Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ

Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of the registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. þ

Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
large accelerated filer, accelerated
filer and smaller reporting company in
Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated
filer o

Accelerated
filer o

Non-accelerated
filer o
(Do not check if a smaller reporting company)

Smaller reporting
Company þ

Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ

The aggregate market value of the Common Stock held by
non-affiliates of the registrant as of the last day of the
registrants most recently completed second quarter on
June 30, 2007 (based upon the closing sale price of the
registrants Common Stock, as reported by The Nasdaq Stock
Market) was $40,499,151.(1)

The number of shares of the registrants Common Stock
outstanding as of March 14, 2008 was 8,354,239.

(1)

Excludes shares held of record on that date by directors and
executive officers and greater than 10% shareholders of the
registrant. Exclusion of such shares should not be construed to
indicate that any such person directly or indirectly possesses
the power to direct or cause the direction of the management of
the policies of the registrant.

Redhook Ale Brewery, Incorporated (the Company or
Redhook) is filing this Amendment No. 3
(Amendment No. 3) to its Annual Report on
Form 10-K
for the fiscal year ended December 31, 2007, originally
filed with the Securities and Exchange Commission
(SEC) on March 26, 2008 (the Original
Filing) and amended by Amendment No. 1 filed on
April 3, 2008 and Amendment No. 2 filed on
April 29, 2008. The Company is filing this Amendment
No. 3 to address comments made by the SEC in connection
with the commissions review of the Original Filing.
Amendment No. 3 reflects revisions to the following items:

Part I., Item 1.
Business  Brewing Operations

Part I., Item 1A. Risk Factors

Part I., Item 7. Managements
Discussion and Analysis of Financial Condition and Results of
Operations

Part I., Item 8. Financial
Statements and Supplementary Data.

Part III., Item 11. Executive Compensation

In addition, in connection with the filing of this Amendment
No. 3 and pursuant to
Rules 12b-15
and 13a-14
under the Securities Exchange Act of 1934, as amended (the
Exchange Act), the Company is including with this
Amendment No. 3 certain currently dated certifications
required by Part IV, Item 15.

Except as described above, no other changes have been made to
the Original Filing, as amended by Amendment No. 1 and
Amendment No. 2. This Amendment No. 3 does not
reflect events occurring after the Original Filing or modify or
update those disclosures affected by subsequent events.
Accordingly, this Amendment No. 3 should be read in
conjunction with the Companys SEC filings made subsequent
to the Original Filing.

This annual report on
Form 10-K
includes forward-looking statements. Generally, the words
believe, expect, intend,
estimate, anticipate,
project, will and similar expressions or
their negatives identify forward-looking statements, which
generally are not historical in nature. These statements are
based upon assumptions and projections that the Company believes
are reasonable, but are by their nature inherently uncertain.
Many possible events or factors could affect the Companys
future financial results and performance, and could cause actual
results or performance to differ materially from those
expressed, including those risks and uncertainties described in
Item 1A.  Risk Factors and those
described from time to time in the Companys future reports
filed with the Securities and Exchange Commission. Caution
should be taken not to place undue reliance on these
forward-looking statements, which speak only as of the date of
this quarterly report.

Redhook Ale Brewery, Incorporated (Redhook or the
Company) has been an independent brewer of craft
beers in the U.S. since the Companys formation in
1981 and is considered to be one of the pioneers of the domestic
craft brewing segment. Redhook produces its specialty bottled
and draft products in two Company-owned breweries, one in the
Seattle suburb of Woodinville, Washington (the Washington
Brewery) and the other in Portsmouth, New Hampshire (the
New Hampshire Brewery). By operating its own
small-batch breweries, the Company believes that it is better
able to control the quantities, types and flavors of beer
produced, while optimizing the quality and consistency of its
products. Management believes that the Companys production
capacity is of high quality and that Redhook is the only
domestic craft brewer that owns and operates substantial
production facilities in both the western region and eastern
region of the U.S.

The Company currently produces nine styles of beer, marketed
under distinct brand names. The Companys flagship brand is
Redhook ESB and its other principal products include
Long Hammer IPA, Redhook Blonde Ale, Blackhook
Porter, and its seasonal offerings Sunrye, Late
Harvest Autumn, Winterhook and Copperhook
Ales. The Company also produces and sells Widmer
Hefeweizen in the midwest and eastern U.S. under a 2003
licensing agreement with Widmer Brothers Brewing Company
(Widmer). In addition to its principal products, the
Company periodically develops and markets new products to test
and measure consumer response to varying styles and flavors.

Since July 2004, the Company has distributed its products in the
western U.S. through Craft Brands Alliance LLC (Craft
Brands), a joint venture between the Company and Widmer.
See Product Distribution  Relationship with
Craft Brands Alliance LLC below. In the midwest and
eastern U.S., the Company has continued to distribute its
products through a distribution agreement with Anheuser-Busch,
Incorporated (A-B). See Product
Distribution  Relationship with Anheuser-Busch,
Incorporated below.

On November 13, 2007, the Company entered into an Agreement
and Plan of Merger (the Merger Agreement) with
Widmer Brothers Brewing Company, an Oregon corporation
(Widmer), pursuant to which Widmer will merge with
and into Redhook, and each outstanding share of capital stock of
Widmer (other than any dissenting shares entitled to statutory
dissenters rights under Oregon law) will be converted into
the right to receive 2.1551 shares of Redhook common stock
(Common Stock). The merger will result in Widmer
shareholders and existing Redhook shareholders each holding
approximately 50% of the outstanding shares of the combined
company (assuming that no Widmer shareholder exercises statutory
dissenters rights, and that currently outstanding options
held by employees, officers, directors and former directors to
acquire shares of Redhook Common Stock are not exercised prior
to the consummation of merger). In connection with the merger,
the Company will change its name to Craft Brewers
Alliance, Inc.

The Company and Widmer have made customary representations,
warranties and covenants in the Merger Agreement, including,
among others, a covenant by Redhook to cause a meeting of
Redhook shareholders to be held to approve issuance of the
shares of Common Stock issuable in the merger. The merger is
subject to customary conditions to closing, including
(i) regulatory approval from the Alcohol and Tobacco Tax
and Trade Bureau and state licensing agencies,
(ii) approval of A-B, (iii) approval by the requisite
vote of Redhook shareholders of the issuance of the shares of
Common Stock issuable in the merger, (iv) approval of the
merger by the requisite vote of Widmer shareholders,
(v) accuracy of the representations and warranties made by
the parties under the Merger Agreement, (vi) compliance by
the parties with their covenants, and (vii) the absence of
any material adverse change to either Redhook or Widmer.

The Merger Agreement was filed as Exhibit 2.1 to the
Companys current report on
Form 8-K
filed on November 13, 2007.

Except where specifically indicated, this Annual Report on
Form 10-K
does not address the effects of the potential merger on the
Company, its customers, suppliers, or employees, Craft Brands
Alliance, or any of the Companys other material
contractual arrangements.

The Company is a brewer in the relatively small craft brewing
segment of the U.S. brewing industry. The domestic beer
market is comprised of ales and lagers produced by large
domestic brewers, international brewers and craft brewers.
Although shipments of craft beer in the United States in 2007
are estimated by industry sources to have increased by
approximately 12% over 2006 shipments, and industry sources
estimated a similar increase in 2006 shipments over 2005, the
share of the domestic beer sales market held by the craft beer
segment remains small. Craft beer shipments in 2007, 2006 and
2005 were approximately 3.8%, 3.4% and 3.5%, respectively, of
total beer shipped in the U.S. Approximately
8.0 million, 7.1 million and 6.0 million barrels
were shipped in the U.S. by the craft beer segment during
2007, 2006 and 2005, while total beer sold in the U.S.,
including imported beer, was approximately 211 million,
210 million and 205 million barrels, respectively. The
number of craft brewers in the U.S. grew dramatically
between 1994 and 2000, increasing from 627 participants at the
end of 1994 and peaking at nearly 1,500 in 2000. At the end of
2007 and 2006, the number of craft brewers was estimated to be
1,406 and 1,394, respectively.

From a peak of 4,131 U.S. breweries in 1873, the number of
breweries had dropped to 1,500 by 1910 as a result of improved
production and distribution. Approximately 760 of these
breweries reopened following Prohibition. During the ensuing
decades, the beer industry concentrated its resources primarily
on marketing pale lagers and pilsners for various reasons,
including: the desire to appeal to the broadest possible segment
of the population; to benefit from economies of scale through
large-scale production techniques; to prolong shelf life through
use of pasteurization processes; and to take advantage of
mass-media advertising reaching consumers nationwide. At the
same time that the beer industry was narrowing its product
offerings to compete more effectively, there was also extensive
consolidation occurring in the industry, still apparent in
todays market composition. According to industry sources,
the three largest domestic brewers accounted for nearly 80% of
total beer shipped in the U.S., including imports, in 2007.

Annual per capita domestic beer consumption has declined from
the highs experienced in the early 1980s, the result of an
elevated concern over health and safety issues, changing tastes,
and evolving affluence and consumption attitudes of a maturing
generation of beer drinkers born after World War II. Since the
early 1980s, a sizable number of consumers have migrated away
from the major domestic products toward a broader taste and
variety in their malt beverages, mirroring similar trends in
other beverage and cuisine categories. Foreign brewers initially
benefited from these evolving consumption patterns. Despite also
being produced by large brewers, European, Canadian and Mexican
imported beers offered a fuller-flavored alternative to the
national brands produced in the U.S.

By the latter half of the 1980s, a new domestic industry segment
had developed in response to the increasing consumer demand for
specialty beers. Across the country, a proliferation of regional
specialty brewers (annually selling more than
15,000 barrels but less than two million barrels of craft
beer brewed at their own facilities), contract brewers (selling
craft beer brewed by a third party to the contract brewers

specifications), microbreweries (selling less than
15,000 barrels per year), and brewpubs (combination
restaurant/breweries) emerged to form the craft beer industry.
This new segment was able to deliver the fuller flavored
products presented by the imported beers while still offering a
fresher product than most imports and one that could appeal to
local taste preferences. Craft beer producers tend to
concentrate on fuller flavors and less on appealing to mass
markets. The strength of consumer demand has enabled certain
craft brewers, such as the Company, to evolve from
microbreweries into regional and national specialty brewers by
constructing larger breweries while still adhering to the
traditional European brewing methods that typically characterize
the craft brewing segment. Industry sources estimate that craft
beer produced by regional specialty brewers, such as the
Company, accounts for approximately two-thirds of total craft
beer sales. Other craft brewers have sought to take advantage of
growing consumer demand and excess industry capacity, when
available, by contract brewing at underutilized facilities.

Since its formation in the 1980s, the rate at which the craft
beer segment has grown has fluctuated. The late 1980s and early
1990s were years of significant growth for the segment, only to
be followed by several years of minimal growth in the late 1990s
and early 2000s. Recent industry reports for 2005, 2006 and 2007
performance, however, indicate favorable trends once again. The
craft beer segments success has been impacted, both
positively and negatively, by the success of the larger
specialty beer category as well as the domestic alcoholic
beverage market. Imported beers have enjoyed resurgence in
demand since the mid-1990s. Certain national domestic brewers
have increased the competition by producing their own
fuller-flavored products to compete against craft beers. In 2001
and 2002, flavored malt beverages were introduced to the market,
initially gaining significant interest but recently experiencing
smaller returns. Finally, the wine and spirits market has seen a
surge in recent years, attributable to competitive pricing,
television advertising, increased merchandising, and increased
consumer interest in wine and spirits.

The Company strives to be the preeminent specialty craft brewing
company in the U.S., producing the highest quality ale products
in company-owned facilities, and marketing and selling them
responsibly through its three-tier distribution system.

The central elements of the Companys business strategy
include:

Production of High-Quality Craft Beers. The
Company is committed to the production of a variety of
distinctive, flavorful craft beers. The Company brews its craft
beers according to traditional European brewing styles and
methods, using only high-quality ingredients to brew in
company-owned and operated brewing facilities. As a symbol of
quality, the Companys products are Kosher certified by the
Orthodox Union, a certification rarely sought by other brewers.
The Company does not intend to compete directly in terms of
production style, pricing or extensive mass-media advertising
typical of large national brands.

Control of Production in Company-Owned
Breweries. The Company builds, owns and operates
its own brewing facilities to optimize the quality and
consistency of its products and to achieve the greatest control
over its production costs. Management believes that its ability
to engage in ongoing product innovation and to control product
quality provides critical competitive advantages. The
Companys highly automated breweries are designed to
produce beer in small batches, while attaining production
economies through automation rather than scale. The Company
believes that its investment in technology enables it to
optimize employee productivity, to contain related operating
costs, to produce innovative beer styles and tastes, and to
achieve the production flexibility afforded by small-batch
brewing, with minimal loss of efficiency and process reliability.

Strategic Distribution Relationship with Industry
Leader. Since October 1994, the Company has
benefited from a distribution relationship with A-B, pursuant to
which the Company distributes its products in substantially all
of its markets through A-Bs wholesale distribution
network. A-Bs domestic network consists of more than 560
independent wholesale distributors, most of which are
geographically contiguous and independently owned and operated,
and 13 branches owned and operated by A-B. This distribution
relationship with A-B has offered efficiencies in product
delivery, state reporting and licensing, billing and
collections. The distribution relationship with A-B has also
provided the Company

with access to A-B distributors at A-Bs distributor
conventions, communications about the Company in printed
distributor materials, and A-B-supported opportunities for the
Company to educate A-B distributors about the Companys
specialty products. The Company believes that these
opportunities to access
A-B
distributors has benefited the Company by creating increased
awareness of and demand for Redhook products among A-B
distributors. The Company is able to reap the benefits of this
distribution relationship with A-B while, as an independent
company, maintaining control over the production and marketing
of its products.

Sales and Marketing Relationship with Craft Brands Alliance
LLC. On July 1, 2004, the Company entered
into agreements with Widmer, headquartered in Portland, Oregon,
to form a joint sales and marketing organization that serves
both companies operations in the western U.S. The
joint organization, named Craft Brands Alliance LLC, advertises,
markets, sells and distributes both Redhooks and
Widmers products to wholesale outlets through a
distribution agreement between Craft Brands and A-B. Management
believes that, in addition to achieving certain synergies, Craft
Brands capitalizes on both companies sales and marketing
skills and complementary product portfolios. The Company
believes that the combination of the two brewers
complementary brand portfolios, led by one focused sales and
marketing organization, not only delivers financial benefits,
but also delivers greater impact at the point of sale.

Operation of Regional Brewing
Facilities. Management believes that, by locating
its production facilities in proximity to the key regional
markets it serves, the Company is able to enjoy distinct
competitive advantages. Shortened delivery times maximize
product freshness and reduce shipping costs. Established brand
awareness of the Companys products and enhanced
familiarity with local consumer tastes enable the Company to
offer select products that appeal to regional preferences. By
pursuing this strategy, the Company believes that it will be
able to preserve its reputation and prestige as a regional craft
brewer.

Promotion of Products. The Company promotes
its products through a variety of advertising programs with its
wholesalers, by training and educating wholesalers and retailers
about the Companys products, through promotions at local
festivals, venues, and pubs, by utilizing its pubs located at
the Companys two breweries, through price discounting,
and, more recently, through Craft Brands. In the midwest and
eastern U.S., the Companys principal advertising programs
include radio, billboards and print advertising (magazines,
newspapers, industry publications). The Company also markets its
products to distributors, retailers and consumers through a
variety of specialized training and promotional methods,
including training sessions for distributors and retailers in
understanding the brewing process, the craft beer segment and
Redhook products. Promotional methods directed towards consumers
include introducing Redhook products on draft in pubs and
restaurants, using promotional items including tap handles,
glassware and coasters, and participating in local festivals and
sports venues to increase brand name recognition. In addition,
the Companys prominently located breweries feature pubs
and retail outlets and offer guided tours to further increase
consumer awareness of Redhook. Craft Brands is responsible for
promotion, advertising and marketing in the western
U.S. and uses methods similar to the Companys in its
promotion of Redhook products.

The Company will occasionally enter into advertising and
promotion programs where the entire program is funded by the
Company; however, in recent years, the Company has favored
co-operative programs where the Companys spending is
matched with an investment by a local distributor. Co-operative
programs align the interests of the Company with those of the
wholesaler whose local market knowledge contributes to more
effective promotions. Sharing these efforts with a wholesaler
helps the Company to leverage their investment in advertising
programs and gives the participating wholesaler a vested
interest in the programs success.

The Company produces a variety of specialty craft beers using
traditional European brewing methods. The Company brews its
beers using only high-quality hops, malted barley, wheat, rye
and other natural ingredients, and does not use any rice, corn,
sugar, syrups or other adjuncts. The Companys beers are
marketed on the basis of freshness and distinctive flavor
profiles. To help maintain full flavor, the Companys
products are not pasteurized. As a result, it is appropriate
that they be kept cool so that oxidation and heat-induced aging
will not adversely affect the original taste, and that they be
distributed and served as soon as possible, generally within
three months after packaging, to maximize freshness and flavor.
The Company distributes its products only in glass bottles and
kegs, and its products are freshness dated for the benefit of
wholesalers and consumers.

The Company currently produces nine principal brands, each with
its own distinctive combination of flavor, color and clarity:

Redhook ESB (ESB). The
Companys flagship brand, ESB, which accounted for
approximately 28%, 36% and 47% of the Companys shipments
in 2007, 2006 and 2005, respectively, is a rich, copper-colored
ale styled by a complex balance between the bitterness of the
hops and the sweetness of a heavier caramel malting.. Shipments
of ESB, as a percentage of total Company shipments, have
declined over the past three years as a result of increases in
sales of Redhooks other products, particularly Redhook
Long Hammer IPA, seasonal offerings, variety packs, licensed
Widmer Hefeweizen as well as beer brewed on a contract
basis for Widmer.

Long Hammer IPA (Long Hammer). A
premium English, pub-style bitter ale, Long Hammer,
accounted for approximately 19%, 16% and 17% of the
Companys shipments in 2007, 2006 and 2005, respectively.
Long Hammer has a strong hop profile that takes advantage
of dry-hopping and Cascade hops because they impart a wonderful
aroma without an overpowering hop taste.

Blackhook Porter (Blackhook). A
London-style porter, Blackhook has an ebony tone, a
pleasant toasted character produced by highly
roasted barley, and a dark malt flavor suggesting coffee and
chocolate, balanced by lively hopping.

Copperhook Ale (Copperhook). This
ale is cold fermented so beer drinkers can enjoy the full flavor
characteristics. With its brilliant copper color, Copperhook
has a light maltiness, pleasant hop aroma, and distinctive
citrus flavor.

Redhook Sunrye Ale
(Sunrye). Gently roasted barley,
delicate hops and a touch of rye combine for a very balanced
lighter style ale. Slightly unfiltered to exude a pearl glow,
Sunrye is styled for warm weather refreshment. Sunrye
is available from April through September in western markets
and April through July in midwest and eastern markets.

Late Harvest Autumn Ale (Autumn
Ale). A roasted malt aroma and distinct
flavors of the Northern Brewer and Saaz hops mark this
full-bodied ale. The two row barley foundation malt gives
Autumn Ale its full body. The specialty malts
 Crystal, German Smoked Munich, Caramel and
Roasted  give it a rich complexity. Autumn Ale
is available August to September in midwest and eastern
markets.

Winterhook. A rich, seasonal holiday ale
formulated specially each year for cold-weather enjoyment,
Winterhook typically is deep in color and rich in flavor,
with complex flavors and a warm finish. Typically, the Company
changes the style of this ale each year. Winterhook is
available during fall and winter months.

The Company also sells Widmer Hefeweizen in the midwest
and eastern U.S. under license from Widmer. Widmer
Hefeweizen is a golden unfiltered wheat beer and is one of
the leading American style Hefeweizens sold in the U.S. In
2003, the Company entered into a licensing agreement with Widmer
to produce and sell

the Widmer Hefeweizen brand in states east of the
Mississippi River. In March 2006, the Widmer Hefeweizen
distribution territory was expanded to include all of the
Companys midwest and eastern markets. In the fourth
quarter of 2006, the Widmer Hefeweizen distribution
territory was again modified when Widmer exercised its
contractual right to eliminate Texas from the Companys
Widmer Hefeweizen distribution territory. Brewing of this
product is conducted at the New Hampshire Brewery under the
supervision and assistance of Widmers brewing staff to
insure the brands quality and matching taste profile. The
licensing agreement automatically renewed on February 1,
2008 for an additional one-year term expiring on
February 1, 2009. The agreement provides for additional
one-year automatic renewals unless either party notifies the
other of its desire to have the agreement expire at the end of
the then existing term at least 150 days prior to such
expiration. The agreement may also be terminated by either party
at any time without cause pursuant to 150 days notice or
for cause by either party under certain conditions.
Additionally, the Company and Widmer have entered into a
secondary agreement providing that if Widmer terminates the
licensing agreement or causes it to expire before
December 31, 2009, Widmer will pay the Company a lump sum
payment to partially compensate the Company for capital
equipment expenditures made at the New Hampshire Brewery to
support Widmers growth. During the term of this agreement,
Redhook will not brew, advertise, market, or distribute any
product that is labeled or advertised as a
Hefeweizen or any similar product in the agreed upon
midwest and eastern territory. Brewing and selling of
Redhooks Hefe-weizen was discontinued in conjunction with
this agreement. The Company believes that this agreement
increases capacity utilization and has strengthened the
Companys product portfolio. The Company shipped 28,800,
30,600 and 25,600 barrels of Widmer Hefeweizen
during the years ended December 31, 2007, 2006 and
2005, respectively. A licensing fee of $432,000, $437,000 and
$399,000 due to Widmer is reflected in the Companys
statement of operations for the years ended December 31,
2007, 2006 and 2005, respectively. If the Widmer licensing
agreement were terminated early, the Company would need to look
to replace the lost volume, either through new or existing
Redhook products or alternative brewing relationships. If the
Company were unable to replace the lost Widmer volume, the loss
of revenue and the resulting excess capacity in the New
Hampshire Brewery would have an adverse effect on the
Companys financial performance.

The Company also sells Pacific Ridge in the western
U.S. In 2003, the Company entered into a purchase and sale
agreement with A-B for the purchase of the Pacific Ridge
brand, trademark and related intellectual property. In
consideration, the Company agreed to pay A-B a fee for
20 years based upon the Companys sales of the brand.
The Company shipped 5,100, 5,900, and 6,000 barrels of
Pacific Ridge during 2007, 2006 and 2005, respectively. A
fee of $71,000, $80,000 and $83,000 due to A-B is reflected in
the Companys statement of operations for the years ended
December 31, 2007, 2006 and 2005, respectively.

In an effort to be responsive to varying consumer style and
flavor preferences, the Company periodically engages in the
development and testing of new products. The Company believes
that the continued success of craft brewers will be affected by
their ability to be innovative and attentive to consumer desires
for new and distinctive taste experiences while maintaining
consistently high product quality. The Companys breweries
allow it to produce small-batch experimental ales within three
weeks. Experimental products are periodically developed and
typically produced in draft form only for on-premise test
marketing at the Companys pubs and selected retail sites.
If the initial consumer reception of an experimental brew is
sufficiently positive, then its taste and formula are refined,
as necessary, and a new Redhook brand may be created. Long
Hammer, Redhook Blonde Ale and many of the Companys
seasonal offerings are examples of products that were developed
in this manner.

The Brewing Process. Beer is made primarily
from four natural ingredients: malted grain, hops, yeast and
water. The grain most commonly used in brewing is barley, owing
to its distinctive germination characteristics that make it easy
to ferment. The Company uses the finest barley malt, using
strains of barley having two rows of grain in each ear. A wide
variety of hops may be used to add seasoning to the brew; some
varieties best confer bitterness, while others are chosen for
their ability to impart distinctive aromas to the beer. Nearly
all the yeasts used to induce or augment fermentation of beer
are of the species Saccharomyces

cerevisiae, which includes both the top-fermenting yeasts
used in ale production and the bottom-fermenting yeasts
associated with lagers.

The brewing process begins when the malt supplier soaks the
barley grain in water, thereby initiating germination, and then
dries and cures the grain through kilning. This process, known
as malting, breaks down complex carbohydrates and proteins so
that they can be easily extracted. The malting process also
imparts color and flavor characteristics to the grain. The cured
grain, referred to as malt, is then sold to the brewery. At the
brewery, various malts are cracked by milling, and mixed with
warm water. This mixture, or mash, is heated and stirred in the
mash tun, allowing the simple carbohydrates and proteins to be
converted into fermentable sugars. Naturally occurring enzymes
help facilitate this process. The mash is then strained and
rinsed in the lauter tun to produce a residual liquid, high in
fermentable sugars, called wort, which then flows into a brew
kettle to be boiled and concentrated. Hops are added during the
boil to impart bitterness, balance and aroma. The specific
mixture of hops and the brewing time and temperature further
affect the flavor of the beer. After the boil, the wort is
strained and cooled before it is moved to a fermentation cellar,
where specially cultured yeast is added to induce fermentation.
During fermentation, the worts sugars are metabolized by
the yeast, producing carbon dioxide and alcohol. Some of the
carbon dioxide is recaptured and absorbed back into the beer,
providing a natural source of carbonation. After fermentation,
the beer is cooled for several days while the beer is clarified
and full flavor develops. Filtration, the final step for a
filtered beer, removes unwanted yeast. At this point, the beer
is in its peak condition and ready for bottling or keg racking.
The entire brewing process of ales, from mashing through
filtration, is typically completed in 14 to 21 days,
depending on the formulation and style of the product being
brewed.

Brewing Equipment. The Company uses highly
automated small-batch brewing equipment. The Washington Brewery
employs a
100-barrel
mash tun, lauter tun, wort receiver, wort kettle, whirlpool
kettle, five 70,000-pound, one 35,000-pound and two 25,000-pound
grain silos, two
100-barrel,
fifty-four
200-barrel,
and ten
600-barrel
fermenters, and two
300-barrel
and four
400-barrel
bright tanks. The New Hampshire Brewery employs a
100-barrel
mash tun, lauter tun, wort receiver, wort kettle, whirlpool
kettle, four 70,000-pound grain silos, including one that was
added in May 2007, two 35,000-pound grain silos, nine
100-barrel,
two
200-barrel
and twenty-six
400-barrel
fermenters, including four that were added in June 2007, two
200-barrel
and two
400-barrel
bright tanks, and an anaerobic waste-water treatment facility
which completes the process

Packaging. The Company packages its craft
beers in both bottles and kegs. Both of the Companys
breweries have fully automated bottling and keg lines. The
bottle filler at both breweries utilizes a carbon dioxide
environment during bottling that is designed to ensure that
minimal oxygen is dissolved in the beer, thereby extending
product shelf life.

Quality Control. The Company monitors
production and quality control at both of its breweries, with
central coordination at the Washington Brewery. Both the
Washington and New Hampshire breweries have an
on-site
laboratory where microbiologists and lab technicians supervise
on-site
yeast propagation, monitor product quality, test products,
measure color and bitterness, and test for oxidation and
unwanted bacteria. The Company also regularly utilizes outside
laboratories for independent product analysis.

Ingredients and Raw Materials. The Company
currently purchases approximately 85% to 90% of its malted
barley from a single supplier and its premium-quality select
hops, grown in the Pacific Northwest, Germany and Czech
Republic, from competitive sources. The Company also
periodically purchases small lots of European hops that it uses
to achieve a special hop character in certain of its beers. In
order to ensure the supply of the hop varieties used in its
products, the Company enters into supply contracts for its hop
requirements. The Company believes that comparable quality
malted barley and hops are available from alternate sources at
competitive prices, although there can be no assurance that
pricing would be consistent with the Companys current
arrangements. The Company currently cultivates its own
Saccharomyces cerevisiae yeast supply and maintains a
separate, secure supply in-house. The Company has access to
multiple competitive sources for packing materials, such as
bottles, labels, six-pack carriers, crowns and shipping cases.

The Companys products are available for sale directly to
consumers in draft and bottles at restaurants, bars and liquor
stores, as well as in bottles at supermarkets, warehouse clubs,
convenience stores and drug stores. Like substantially all craft
brewers, the Companys products are delivered to these
retail outlets through a network of local distributors whose
principal business is the distribution of beer and, in some
cases, other alcoholic beverages, and who traditionally have
distribution relationships with one or more national beer
brands. To promote and educate the public on Redhooks
products, the Company offers its products directly to consumers
at the Companys two on-premise retail establishments
located at the Companys breweries, the Forecasters Public
House in Woodinville, Washington and the Cataqua Public House in
Portsmouth, New Hampshire.

Prior to establishing a distribution relationship with A-B in
1994, the Company distributed its products regionally through
multiple distributors, many of which were part of the A-B
distribution network, in eight western states: Washington,
California (northern), Oregon, Idaho, Montana, Wyoming, Colorado
and Alaska. In October 1994, the Company entered into a
distribution agreement with A-B (the Distribution
Alliance) pursuant to which the Company began distributing
its products, for any new markets entered, exclusively through
this agreement. Existing wholesalers continued to distribute the
Companys products outside of the Distribution Alliance. By
2003, 72% of the Companys sales volume was through
Alliance distributors.

On July 1, 2004, the Company entered into a new
distribution agreement with A-B (the A-B Distribution
Agreement) pursuant to which the Company continues to sell
its product in the midwest and eastern U.S. through sales
to A-B and distribute its product through the A-B distribution
network.

On July 1, 2004, the Company also entered into agreements
with Widmer with respect to the operation of their joint venture
sales and marketing entity, Craft Brands. Under their agreements
with Craft Brands, the Company manufactures and sells its
product to Craft Brands at a price substantially below wholesale
pricing levels; Craft Brands, in turn, advertises, markets,
sells and distributes the product to wholesale outlets in the
western U.S. through a distribution agreement between Craft
Brands and A-B.

Currently, there are no Company products distributed in the
U.S. by a wholesaler that are not distributed pursuant to
the A-B Distribution Agreement or the distribution agreement
between Craft Brands and A-B.

For additional information regarding the Companys
relationship with A-B and Craft Brands, see Relationship
with Anheuser-Busch, Incorporated and Relationship
with Craft Brands Alliance LLC below.

A-B, whose products accounted for approximately 48.5% of total
beer shipped by volume in the U.S. in 2007, including
imports, distributes its products throughout the
U.S. through a network of more than 560 independent
wholesale distributors, most of whom are geographically
contiguous and independently owned and operated, and
13 branches owned and operated by A-B. The Company believes
that the typical A-B distributor is financially stable and has
both a long-standing presence and a substantial market share of
beer sales in its territory.

The Company chose to align itself with A-B through the 1994
Distribution Alliance, and again through the 2004 A-B
Distribution Agreement and Craft Brands distribution
agreement with A-B, to gain access to quality distribution
throughout the U.S. The Company was the first and is the
largest independent craft brewer to have a formal distribution
agreement with a major U.S. brewer. Management believes
that the Companys competitors in the craft beer segment
generally negotiate distribution relationships separately with
distributors in each locality and, as a result, typically
distribute through a variety of wholesalers representing
differing national beer brands with uncoordinated territorial
boundaries. Because A-Bs distributors are assigned
territories that generally are contiguous, the distribution
relationship with A-B enables the Company to reduce the gaps and
overlaps in distribution coverage often experienced by the
Companys competitors.

In 2007, 2006 and 2005, the Company sold approximately 107,900,
101,400 and 85,100 barrels, respectively, to A-B through
the A-B Distribution Agreement, accounting for approximately
34%, 37% and 38%, respectively, of the Companys sales
volume for the period. During these same periods, the Company
shipped approximately 121,900, 122,600 and 126,500 barrels,
or 38%, 45% and 56% of the Companys sales volume, to Craft
Brands.

The Companys most significant wholesaler, K&L
Distributors, Inc. (K&L), is responsible for
distribution of the Companys products in most of King
County, Washington, including Seattle, Washington. K&L
accounted for approximately 8%, 11% and 12%, respectively, of
total sales volume in 2007, 2006 and 2005, respectively.
Shipments of the Companys product to K&L during these
years were marketed through Craft Brands. Due to state liquor
regulations, the Company sells its product in Washington State
directly to third-party beer distributors and returns a portion
of the revenue to Craft Brands based upon a contractually
determined formula.

Relationship
with Anheuser-Busch, Incorporated

On July 1, 2004, the Company completed the restructuring of
its ongoing relationship with A-B. Pursuant to an exchange and
recapitalization agreement between the Company and A-B (the
Exchange and Recapitalization Agreement), the
Company issued 1,808,243 shares of its Common Stock to A-B
in exchange for 1,289,872 shares of Series B Preferred
Stock held by A-B. The Series B Preferred Stock, reflected
in the Companys July 1, 2004 balance sheet at
approximately $16.3 million, was subsequently cancelled. In
connection with the exchange, the Company also paid
$2.0 million to A-B in November 2004. A-B was also granted
certain contractual registration rights with respect to its
shares of the Companys Common Stock. As of
December 31, 2007 and 2006, A-B owned approximately 33.1%
and 33.3%, respectively, of the Companys Common Stock.

Additionally, pursuant to the Exchange and Recapitalization
Agreement, A-B is entitled to designate two members of the board
of directors of the Company. A-B also generally has the
contractual right to have one of its designees sit on each
committee of the board of directors of the Company. The Exchange
and Recapitalization Agreement also contains limitations on the
Companys ability to take certain actions without
A-Bs prior consent, including but not limited to the
Companys ability to issue equity securities or acquire or
sell assets or stock, amend its Articles of Incorporation or
bylaws, grant board representation rights, enter into certain
transactions with affiliates, distribute its products in the
U.S. other than through A-B, Craft Brands or as provided in
the A-B Distribution Agreement, voluntarily delist or terminate
its listing on the Nasdaq Stock Market, or dispose any of its
interest in Craft Brands. Further, if the A-B Distribution
Agreement or the distribution agreement between Craft Brands and
A-B is terminated, or the distribution of Redhook products is

terminated by Craft Brands under the distribution agreement
between Craft Brands and A-B, A-B has the right to solicit and
negotiate offers from third parties to purchase all or
substantially all of the assets or securities of the Company or
to enter into a merger or consolidation transaction with the
Company and the right to cause the board of directors of the
Company to consider any such offer.

On July 1, 2004, the Company also entered into the A-B
Distribution Agreement. The A-B Distribution Agreement provides
for the distribution of the Companys products in the
midwest and eastern U.S. (the Eastern
Territory), which represents those states not covered by
the Supply, Distribution and Licensing Agreement between the
Company and Craft Brands. The structure of the new A-B
Distribution Agreement is substantially similar to the
Companys prior arrangement with A-B. Under the A-B
Distribution Agreement, the Company has granted A-B the first
right to distribute Redhook products, including future new
products, in the Eastern Territory. The Company is responsible
for marketing its products to A-Bs distributors in the
Eastern Territory, as well as to retailers and consumers. The
A-B distributors then place orders with the Company, through
A-B, for Redhook products. The Company separately packages and
ships the orders in refrigerated trucks to the A-B distribution
center nearest to the distributor or, under certain
circumstances, directly to the distributor.

The A-B Distribution Agreement has a term that expires on
December 31, 2014, subject to automatic renewal for an
additional ten-year period unless A-B provides written notice of
non-renewal to the Company on or prior to June 30, 2014.
The A-B Distribution Agreement is also subject to early
termination, by either party, upon the occurrence of certain
events. The A-B Distribution Agreement may be terminated
immediately, by either party, upon the occurrence of any one or
more of the following events:

1) a material default by the other party in the performance
of any of the provisions of the A-B Distribution Agreement or
any other agreement between the parties, which default is either:

i) curable within 30 days, but is not cured within
30 days following written notice of default; or

ii) not curable within 30 days and either:

(1) the defaulting party fails to take reasonable steps to
cure as soon as reasonably possible following written notice of
such default; or

(2) such default is not cured within 90 days following
written notice of such default;

2) default by the other party in the performance of any of
the provisions of the A-B Distribution Agreement or any other
agreement between the parties, which default is not described in
(1) above and which is not cured within 180 days
following written notice of such default;

3) the making by the other party of an assignment for the
benefit of creditors; or the commencement by the other party of
a voluntary case or proceeding or the other partys consent
to or acquiescence in the entry of an order for relief against
such other party in an involuntary case or proceeding under any
bankruptcy, reorganization, insolvency or similar law;

4) the appointment of a trustee or receiver or similar
officer of any court for the other party or for a substantial
part of the property of the other party, whether with or without
the consent of the other party, which is not terminated within
60 days from the date of appointment thereof;

5) the institution of bankruptcy, reorganization,
insolvency or liquidation proceedings by or against the other
party without such proceedings being dismissed within
90 days from the date of the institution thereof;

6) any representation or warranty made by the other party
under or in the course of performance of the A-B Distribution
Agreement that is false in material respects; or

7) the distribution agreement between Craft Brands and A-B
is terminated or the distribution thereunder of the products of
Redhook is terminated pursuant to its terms.

Additionally, the A-B Distribution Agreement may be terminated
by A-B, upon six months prior written notice to the Company, in
the event:

1) the Company engages in certain Incompatible Conduct
which is not curable or is not cured to
A-Bs
satisfaction (in A-Bs sole opinion) within 30 days.
Incompatible Conduct is defined as any act or omission of the
Company that, in A-Bs determination, damages the
reputation or image of A-B or the brewing industry;

2) any A-B competitor or affiliate thereof acquires 10% or
more of the outstanding equity securities of the Company, and
one or more designees of such person becomes a member of the
board of directors of the Company;

3) the current chief executive officer of the Company
ceases to function as chief executive officer and within six
months of such cessation a successor satisfactory in the sole,
good faith discretion of A-B is not appointed;

4) the Company is merged or consolidated into or with any
other person or any other person merges or consolidates into or
with the Company; or

5) A-B or its corporate affiliates incur any liability or
expense as a result of any claim asserted against them by or in
the name of the Company or any shareholder of the Company as a
result of the equity ownership of A-B or its affiliates in the
Company, or any equity transaction or exchange between A-B or
its affiliates and the Company, and the Company does not
reimburse and indemnify A-B and its corporate affiliates on
demand for the entire amount of such liability and expense.

Generally, the Company pays the following fees to A-B in
connection with the sale of the Companys products:

Margin. In connection with all sales through
the July 1, 2004 A-B Distribution Agreement, the Company
pays a Margin fee to A-B. The Margin does not apply to sales
from the Companys retail operations or to dock sales. The
Margin also does not apply to the Companys sales to Craft
Brands because Craft Brands pays a comparable fee to A-B on its
resale of the product. The A-B Distribution Agreement also
provides that the Company shall pay an additional fee to A-B on
all shipments that exceed fiscal year 2003 shipments in the same
territory (the Additional Margin).

During the year ended December 31, 2007, the Margin was
paid to A-B on shipments totaling 107,900 barrels to 532
distribution points. During the year ended December 31,
2006, the Margin was paid to A-B on shipments totaling
101,400 barrels to 503 distribution points. During the year
ended December 31, 2005, the Margin was paid to A-B on
shipments totaling 85,100 barrels to 472 distribution
points. Because 2007, 2006 and 2005 shipments in the midwest and
eastern U.S. each exceeded 2003 shipments in the same
territory, the Company paid A-B the Additional Margin on 30,000,
23,000 and 7,000 barrels, respectively. The Margin and
Additional Margin is reflected as a reduction of sales in the
Companys statements of operations.

Invoicing Cost. Since July 1, 2004, the
invoicing cost is payable on sales through the A-B Distribution
Agreement. The fee does not apply to sales by the Companys
retail operations or to dock sales. The fee also does not apply
to the Companys sales to Craft Brands because Craft Brands
pays a comparable fee to A-B. The basis for this charge is
number of pallet lifts.

According to the terms of the A-B Distribution Agreement, the
fee per pallet lift is generally adjusted on January 1 of each
year.

Staging Cost and Cooperage Handling
Charge. The Staging Cost is payable on all sales
through the
A-B
Distribution Agreement that are delivered to an A-B brewery or
A-B distribution facility. The fee does not apply to product
shipped directly to a wholesaler or wholesaler support center.
The Cooperage Handling Charge is payable on all draft sales
through the A-B Distribution Agreement that are delivered to a
wholesaler support center or directly to a wholesaler. The basis
for these fees is number of pallet lifts. According to the

terms of the A-B Distribution Agreement, the Staging Cost and
Cooperage Handling Charge fees are generally adjusted on January
1 of each year.

Inventory Manager Fee. The Inventory Manager
Fee is paid to reimburse A-B for a portion of the salary of a
corporate inventory management employee, a substantial portion
of whose responsibilities are to coordinate and administer
logistics of the Companys product distribution to
wholesalers. This fee has remained relatively constant since
2004.

The Invoicing Cost, Staging Cost, Cooperage Handling Charge and
Inventory Manager Fee are reflected in cost of sales in the
Companys statement of operations. These fees totaled
approximately $150,000, $129,000 and $249,000 for the years
ended December 31, 2007, 2006 and 2005, respectively. These
fees were lower in 2006 compared to 2005 and 2007 as the Company
recognized a refund of $124,000 from A-B in 2006 from over
billed invoicing costs from 1995 through 2005.

Wholesaler Support Center Fee. In certain
instances, the Company may ship its product to A-B wholesaler
support centers rather than directly to the wholesaler.
Wholesaler support centers assist the Company by consolidating
small wholesaler orders with orders of other A-B products prior
to shipping to the wholesaler. A wholesaler support center fee
of $171,000, $158,000 and $32,000 is reflected in the
Companys statements of operations for the years ended
December 31, 2007, 2006 and 2005, respectively.

Management believes that the benefits of the distribution
arrangement with A-B, particularly the increased sales volume
and efficiencies in delivery, state reporting and licensing,
billing and collections, are significant to the Companys
business. The Company believes that the existence of the A-B
Distribution Agreement, presentations by Redhooks
management at A-Bs distributor conventions, A-B
communications about Redhook in printed distributor materials,
and A-B supported opportunities for Redhook to educate A-B
distributors about its specialty products have resulted in
increased awareness of and demand for Redhook products among
A-Bs distributors.

If the A-B Distribution Agreement were terminated early, as
described above, it would be extremely difficult for the Company
to rebuild its distribution network without a severe negative
impact on the Companys sales and results of operations. In
such an event, Redhook would be faced with finding another
national distribution partner similar to A-B, and entering into
a complex distribution and investment arrangement with that
entity, or with negotiating separate distribution agreements
with individual distributors throughout the U.S. Currently,
Redhook distributes its product through a network of more than
560 independent wholesale distributors, most of whom are
geographically contiguous and independently owned and operated,
and 13 branches owned and operated by A-B. If we had to
negotiate separate agreements with individual distributors, such
an undertaking would necessarily take a significant amount of
time to complete, during which time Redhooks products
would not be distributed. It would also be extremely difficult
to build a seamless and contiguous distribution network similar
to the one we currently enjoy through A-B. Additionally, we
would need to raise significant capital to fund the development
of a new distribution network and continue operations. There can
be no guarantee that financing would be available when needed,
either from our current lender or from the capital markets, or
that any such financing would be on commercially reasonable
terms. Given the difficulty that we would face if we needed to
rebuild our distribution network, if the current distribution
arrangement with AB were to be terminated, it is unlikely
Redhook would be able to continue as a going concern.

On July 1, 2004, the Company entered into agreements with
Widmer with respect to the operation of Craft Brands. Craft
Brands is a joint venture between the Company and Widmer that
purchases products from the Company and Widmer and markets,
advertises, sells and distributes these products in the Western
Territory pursuant to a distribution agreement with A-B (the
Craft Brands Distribution Agreement). The Western
Territory includes the following western states: Alaska,
Arizona, California, Colorado, Hawaii, Idaho, Montana,
New Mexico, Nevada, Oregon, Washington and Wyoming. The
Company and Widmer are each a 50% member of Craft Brands and
each has the right to designate two directors to its six member
board. A-B is entitled to designate the remaining two directors.

The Company and Widmer have entered into an operating agreement
with Craft Brands (the Operating Agreement) that
governs the operations of Craft Brands and the obligations of
its members, including capital contributions, loans and
allocation of profits and losses.

The Operating Agreement requires the Company to make certain
capital contributions to support the operations of Craft Brands.
Contemporaneous with the execution of the Operating Agreement,
the Company made a 2004 sales and marketing capital contribution
in the amount of $250,000. The agreement designated this sales
and marketing capital contribution to be used by Craft Brands
for expenses related to the marketing, advertising and promotion
of the Companys products. In February 2007 and in February
2008, the Company and Widmer amended the Operating Agreement to
require an additional sales and marketing contribution in 2009
if the volume of sales of Redhook products in 2008 in the
Western Territory is less than 92% of the volume of sales of
Redhook products in 2003 in the Western Territory. Under these
amendments, Redhooks maximum 2009 sales and marketing
contribution was reduced to $310,000, reflecting the
Companys commitment to expand the production capacity of
its Washington and New Hampshire breweries to produce more
Widmer products. Widmer also has a sales and marketing
contribution under the amended Operating Agreement with similar
terms that is capped at $750,000. If required, the 2009 sales
and marketing contribution is due by February 1, 2009.
Because sales in the craft beer industry generally reflect a
degree of seasonality and the Company has historically operated
with little or no backlog, the Companys ability to predict
sales for future periods is limited. Accordingly, the Company
cannot predict to what degree, if at all, the Company will be
required to make this 2009 sales and marketing contribution. If
the Company is required to make this additional sales and
marketing contribution in 2009, the Companys available
cash will decrease and income from Craft Brands will decrease by
the amount of the contribution, which will be allocated 100% to
the Company. The Operating Agreement also obligates the Company
and Widmer to make other additional capital contributions only
upon the request and consent of the Craft Brands board of
directors.

The Operating Agreement also requires the Company and Widmer to
make loans to Craft Brands to assist Craft Brands in conducting
its operations and meeting its obligations. To the extent cash
flow from operations and borrowings from financial institutions
is not sufficient for Craft Brands to meet its obligations, the
Company and Widmer are obligated to lend to Craft Brands the
funds the president of Craft Brands deems necessary to meet such
obligations. Contemporaneous with the execution of the Operating
Agreement, the Company made a member loan to Craft Brands of
$150,000. Craft Brands repaid this loan plus accrued interest in
December 2004.

The Operating Agreement additionally addresses the allocation of
profits and losses of Craft Brands. After giving effect to the
allocation of the sales and marketing capital contribution, if
any, and after giving effect to income attributable to the
shipments of the Kona Brewery LLC (Kona) brand,
which was shared differently between the Company and Widmer
through 2006, the remaining profits and losses of Craft Brands
are allocated between the Company and Widmer based on the cash
flow percentages of 42% and 58%, respectively. Net cash flow, if
any, will generally be distributed monthly to the Company and
Widmer based upon the cash flow percentages. No distribution
will be made to the Company or Widmer unless, after the
distribution is made, the assets of Craft Brands will be in
excess of its liabilities, with the exception of liabilities to
members, and Craft Brands will be able to pay its debts as they
become due in the ordinary course of business.

The Company also entered into a Supply, Distribution and
Licensing Agreement with Craft Brands (the Supply and
Distribution Agreement). Under the Supply and Distribution
Agreement, the Company is required to manufacture and sell its
product directly to Craft Brands (except in states where laws
require sales to be made directly from Redhook to wholesalers)
and Craft Brands advertises, markets and distributes the
products to wholesale outlets in the Western Territory through
the Craft Brands Distribution Agreement with A-B. The Company
has granted Craft Brands a license to use Redhook intellectual
property in connection with these efforts to advertise, market,
sell and distribute the Companys products in the Western
Territory. The Supply and Distribution Agreement also gives the
Company the right to manufacture certain products of Widmer for
sale to Craft Brands if Widmer is unable to manufacture the
quantity ordered by Craft Brands. In addition, if sales of the
Companys products decrease as compared to previous year
sales, the Company has an option to manufacture Widmer products
in an amount equal to the lower of (i) the Companys
product decrease or (ii) the Widmer product increase.

The Supply and Distribution Agreement also provides that Craft
Brands may elect to discontinue distributing a Redhook product
if sales volume of such product declines to less than 20% of the
total volume of all Redhook products and the volume of
Redhooks product in the prior year decreased by more than
10% as compared to the year prior.

The territory covered by the Supply and Distribution Agreement
may be expanded to cover one or more of the following states, at
Craft Brands request: Arkansas, Iowa, Kansas, Louisiana,
Minnesota, Missouri, Nebraska, North Dakota, Oklahoma, South
Dakota and Texas.

Widmer has also entered into a Supply, Distribution and
Licensing Agreement with Craft Brands upon substantially similar
terms.

The Supply and Distribution Agreement has an indefinite term,
subject to early termination upon the occurrence of certain
events. The Supply and Distribution Agreement may be terminated
immediately, by either party, upon the occurrence of any one or
more of the following events:

1) the other party fails to timely make any payment
required under the Supply and Distribution Agreement for a
period of 60 days following written notice thereof;

2) the other party fails to perform any other material
obligation under the Supply and Distribution Agreement and such
failure remains uncured for a period of 60 days following
written notice thereof;

3) the other party becomes the subject of insolvency or
bankruptcy proceedings, ceases doing business, makes an
assignment of assets for the benefit of creditors, dissolves, or
has a trustee appointed for all or a substantial portion of such
partys assets;

4) any government authority makes a final decision
invalidating a substantial portion of the Supply and
Distribution Agreement;

5) either party finds that complying with any law or
regulation relating to fulfilling its obligations under the
Supply and Distribution Agreement would be commercially
unreasonable and failure to comply with the law or regulation
would subject such party or any of its personnel to a monetary
or criminal penalty;

6) the Craft Brands Distribution Agreement with A-B
terminates for any reason; or

7) the Operating Agreement terminates for any reason.

Additionally, Craft Brands may, upon notice to the Company,
terminate the Supply and Distribution Agreement if the Company
causes Craft Brands to be in default in its obligations under
the Craft Brands Distribution Agreement with A-B and the Company
either (a) fails to take all actions necessary to cause
Craft Brands to cure such default or (b) fails to pay on
demand certain direct or indirect costs arising out of or
related to such default. Craft Brands may also terminate the
Supply and Distribution Agreement and cease advertising,
marketing, or distributing one or more of the Companys
products if an event of default occurs under the Craft Brands
Distribution Agreement that gives A-B the right to terminate
that agreement and the Company caused such event of default.

If the Supply and Distribution Agreement were terminated early,
as described above, it would be extremely difficult for the
Company to rebuild its distribution network and re-launch its
marketing and advertising activities in the Western Territory
without a severe negative impact on the Companys sales and
results of operations. It is likely that the Company would need
to raise additional funds to develop a new distribution network.
There cannot be any guarantee that the Company would be able to
successfully rebuild all, or part, of its distribution network
or that any additional financing would be available when needed,
or that any such financing would be on commercially reasonable
terms. Additionally, termination of the Supply and Distribution
Agreement could cause a default under the Craft Brands
Distribution Agreement, which could in turn cause the Company to
be in default under the A-B Distribution Agreement.

The Company has assessed its investment in Craft Brands pursuant
to the provisions of Financial Accounting Standards Board
(FASB) Interpretation No. 46 Revised,
Consolidation of Variable Interest

Entities  an Interpretation of ARB No. 51,
(FIN 46R) and has concluded that its
investment in Craft Brands meets the definition of a variable
interest entity but that the Company is not the primary
beneficiary. In accordance with FIN 46R, the Company has
not consolidated the financial statements of Craft Brands with
the financial statements of the Company, but instead accounted
for its investment in Craft Brands under the equity method, as
outlined by Accounting Principle Board (APB) Opinion
No. 18, The Equity Method of Accounting for Investments
in Common Stock. The Company recognized $2,826,000,
$2,655,000 and $2,392,000 of undistributed earnings related to
its investment in Craft Brands for the years ended
December 31, 2007, 2006 and 2005, respectively. The Company
received cash distributions of $2,538,000, $2,621,000 and
$2,769,000, representing its share of the net cash flow of Craft
Brands for the years ended December 31, 2007, 2006 and
2005, respectively. The Companys share of the earnings of
Craft Brands contributed a significant portion of income to the
Companys results of operations. Separate financial
statements for Craft Brands are filed with this Annual Report on
Form 10-K
in Part IV., Item 15. Exhibits and Financial
Statement Schedules, in accordance with
Rule 3-09
of
Regulation S-X.

The Company promotes its products through a variety of
advertising programs with its wholesalers, by training and
educating wholesalers and retailers about the Companys
products, through promotions at local festivals, venues, and
pubs, by utilizing the pubs located at the Companys two
breweries, through price discounting, and, most recently,
through Craft Brands.

The Company advertises its products by utilizing radio,
billboard and print advertising in key markets and by
participating in a co-operative program with its distributors
whereby the Companys spending is matched by the
distributor. Since 2000, the Company has allocated a larger
share of its advertising budget each year to these co-operative
programs. The Company believes that the financial commitment by
the distributor helps align the Companys interests with
those of its distributor, and the distributors knowledge
of the local market results in an advertising and promotion
program that is targeted in a manner that will best promote
Redhook and its products. In 2005, the Company reduced its co-op
advertising, but continued its promotion program and limited
media advertising in select eastern U.S. markets.
Expenditures for the co-op program and media advertising program
totaled $443,000, $365,000 and $533,000 in 2007, 2006 and 2005,
respectively. Craft Brands served the operations of Redhook in
the Western Territory for advertising and marketing for all of
2007, 2006 and 2005.

The Companys sales and marketing staff offers education,
training and other support to wholesale distributors of the
Companys products. Because the Companys wholesalers
generally also distribute much higher volume national beer
brands and commonly distribute other specialty brands, a
critical function of the sales and marketing staff is to elevate
each distributors awareness of the Companys products
and to maintain the distributors interest in promoting
increased sales of these products. This is accomplished
primarily through personal contact with each distributor,
including
on-site
sales training, educational tours of the Companys
breweries, and promotional activities and expenditures shared
with the distributors. The Companys sales representatives
also provide other forms of support to wholesale distributors,
such as direct contact with restaurant and grocery chain buyers,
direct involvement in the design of grocery store displays,
stacking and merchandising of beer inventory and supply of
point-of-sale materials.

The Companys sales representatives devote considerable
effort to the promotion of on-premise consumption at
participating pubs and restaurants. The Company believes that
educating retailers about the freshness and quality of the
Companys products will in turn allow retailers to assist
in educating consumers. The Company considers on-premise product
sampling and education to be among its most effective tools for
building brand awareness with consumers and establishing
word-of-mouth reputation. On-premise marketing is also
accomplished through a variety of other point-of-sale tools,
such as neon signs, tap handles, coasters, table tents, banners,
posters, glassware and menu guidance. The Company seeks to
identify its products with local markets by participating in or
sponsoring cultural and community events, local music and other
entertainment venues, local craft beer festivals and cuisine
events, and local sporting events.

The Companys breweries also play a significant role in
increasing consumer awareness of the Companys products and
enhancing Redhooks image as a craft brewer. Many visitors
take tours at the Companys breweries. Both of the
Companys breweries have a retail pub
on-site
where the Companys products are served. In addition, the
breweries have meeting rooms that the public can rent for
business meetings, parties and holiday events, and that the
Company uses to entertain and educate distributors, retailers
and the media about the Companys products. See
Item 2. Properties. The Company also sells various
items of apparel and memorabilia bearing the Companys
trademarks at its pubs, which creates further awareness of the
Companys beers and reinforces the Companys quality
image.

To further promote retail bottled product sales and in response
to local competitive conditions, the Company regularly offers
post-offs, or price discounts, to distributors in
most of its markets. Distributors and retailers usually
participate in the cost of these price discounts.

The Craft Brands joint sales and marketing organization serves
the operations of Redhook and Widmer in the Western Territory by
advertising, marketing, selling and distributing both
companies products to wholesale outlets through a
distribution agreement between Craft Brands and A-B. Similar to
the Company, Craft Brands promotes its products through a
variety of advertising programs with its wholesalers, through
training and education of wholesalers and retailers, through
promotions at local festivals, venues, and pubs, by utilizing
the pubs located at the Companys two breweries, and
through price discounting. Management believes that, in addition
to achieving certain synergies by combining sales and marketing
forces, Craft Brands is able to capitalize on both
companies sales and marketing skills and complementary
product portfolios. The Company believes that the combination of
the two brewers complementary brand portfolios, led by one
focused sales and marketing organization, will not only deliver
financial benefits, but will also deliver greater impact at the
point-of-sale.

Sales of the Companys products generally reflect a degree
of seasonality, with the first and fourth quarters historically
being the slowest and the rest of the year typically
demonstrating stronger sales. The volume of sales may also be
affected by weather conditions. Therefore, the Companys
results for any quarter may not be indicative of the results
that may be achieved for the full fiscal year.

The Company competes in the highly competitive craft brewing
market as well as in the much larger specialty beer market,
which encompasses producers of import beers, major national
brewers that have introduced fuller-flavored products, and large
spirit companies and national brewers that produce flavored
alcohol beverages. Beyond the beer market, craft brewers have
also faced competition from producers of wines and spirits. See
Industry Background above.

Competition within the domestic craft beer segment and the
specialty beer market is based on product quality, taste,
consistency and freshness, ability to differentiate products,
promotional methods and product support, transportation costs,
distribution coverage, local appeal and price.

The craft beer segment is highly competitive due to the
proliferation of small craft brewers, including contract
brewers, and the large number of products offered by such
brewers. Craft brewers have also encountered more competition as
their peers expand distribution. Just as the Company expanded
distribution of its products to markets outside of its home in
the Pacific Northwest, so have other craft brewers expanded
distribution of their products to other regions of the country,
leading to an increase in the number of craft brewers in any
given market. Competition also varies by regional market.
Depending on the local market preferences and distribution, the
Company has encountered strong competition from microbreweries,
from other regional specialty brewers such as Sierra Nevada
Brewing Company, Deschutes Brewery, Pyramid Breweries and New
Belgium Brewing Company, as well as from national brewers such
as Boston Beer Company. Because of the large number of
participants and number of different products offered in this
segment, the competition for bottled product placements and
especially for draft beer placements has intensified. Although
certain of these competitors distribute their products
nationally and may have greater

financial and other resources than the Company, management
believes that the Company possesses certain competitive
advantages, including its Company-owned production facilities
and its relationships with A-B and Craft Brands.

The Company also competes against producers of imported brands,
such as Heineken, Corona Extra, Bass and Guinness. Most of these
foreign brewers have significantly greater financial resources
than the Company. Although imported beers currently account for
a greater share of the U.S. beer market than craft beers,
the Company believes that craft brewers possess certain
competitive advantages over some importers, including lower
transportation costs, no importation costs, proximity to and
familiarity with local consumers, a higher degree of product
freshness, eligibility for lower federal excise taxes and
absence of currency fluctuations.

In response to the growth of the craft beer segment, most of the
major domestic brewers have introduced fuller-flavored beers.
While these product offerings are intended to compete with craft
beers, many of them are brewed according to methods used by the
major national brewers. Although increased participation by the
major national brewers increases competition for market share
and can heighten price sensitivity within the craft beer
segment, the Company believes that their participation tends to
increase advertising, distribution and consumer education and
awareness of craft beers, and thus may contribute to further
growth of this industry segment.

In the past few years, several major distilled spirits producers
and national brewers have introduced flavored alcohol beverages.
Products such as Smirnoff Ice, Bacardi Silver and Mikes
Hard Lemonade demonstrate continued growth. The Company believes
sales of these products, along with strong growth in the import
and craft beer segments of the malt beverage industry,
contributed to an increase in the overall U.S. alcohol
market. The producers of these products have significantly
greater financial resources than the Company and these products
appear to draw a portion of overlapping consumers away from
imports and craft beers. The success of the flavored alcohol
beverages will likely subject the Company to increased
competition.

Competition for consumers of craft beers has also come from wine
and spirits. Some of the growth in the past five years in the
wine and spirits market, industry sources believe, has been
drawn from the beer market. This growth appears to be
attributable to competitive pricing, television advertising,
increased merchandising, and increased consumer interest in wine
and spirits.

A significant portion of the Companys sales continue to be
in the Pacific Northwest region, which the Company believes is
one of the most competitive craft beer markets in the U.S., both
in terms of number of participants and consumer awareness. The
Company faces extreme competitive pressure in Washington State,
which is not only the Companys largest market, but is also
its oldest market. Since 2003, the Company has experienced an
18.5% decline in sales volume in Washington state. The Company
believes that the Pacific Northwest, and Washington State in
particular, offers significant competition to its products, not
only from other craft brewers but also from the growing wine
market and from flavored alcohol beverages. This intense
competition is magnified because the Companys brand is
viewed as being relatively mature. Focus studies in late 2004
indicated that, while the Companys brand does possess
brand awareness among target consumers, it also appeared to not
attract key consumers who seem to be more interested in
experimenting with new products. These studies resulted in Craft
Brands focusing its 2005 marketing efforts on updating the
Redhook brand image to stimulate demand. In the first half of
2005, Craft Brands introduced in the western U.S. several
major marketing initiatives, including a proprietary Redhook
bottle, a new packaging design and a new marketing campaign,
aimed at updating the Redhook brand image. In the second half of
2005, the new packaging design was introduced in the midwest and
eastern U.S.

Management believes that the beer industry is influenced, both
positively and negatively, by individual relationships with
retailers. In Washington State, where some of those
relationships have existed for many years, the transition to
Craft Brands appears to have had some negative impact on those
relationships. The transition took longer than anticipated, and
nearly all Company sales staff responsible for the Washington
State market left the Company in 2004. Since 2004, sales of the
Companys products in the Western Territory have declined
by approximately 3.6%. Pricing of the Companys products
has increased and the level of promotion and discounting has
declined, allowing the Company to achieve higher revenue per
barrel; however, management believes there is a direct
correlation to lower sales caused by higher net pricing. During
this same

period, Craft Brands has continued to experience success in
selling Widmer and Kona products. Although the Company enjoys
the benefits of those successes through its profit-sharing
arrangement with Craft Brands, the Company believes it is
critical for Craft Brands to deliver success with Redhook
products in addition to other products. The Company has
communicated this concern to Craft Brands and is working with
Craft Brands management to establish new brand management
throughout the portfolio of Redhook products. Craft Brands also
responded to this concern by re-emphasizing its commitment to
Redhook products and focusing its sales efforts on the
Companys Long Hammer IPA. This attention has
resulted in an increase in shipments of Long Hammer IPA
over 2006; however, shipments of the Companys other
products in the Craft Brands territory have not shown
improvement in 2007 over 2006. The Company continues to work
with Craft Brands management to improve performance.

The Companys business is highly regulated at federal,
state and local levels. Various permits, licenses and approvals
necessary to the Companys brewery and pub operations and
the sale of alcoholic beverages are required from various
agencies, including the U.S. Treasury Department, Alcohol
and Tobacco Tax and Trade Bureau (the TTB) (formerly
the Bureau of Alcohol, Tobacco and Firearms), the
U.S. Department of Agriculture, the U.S. Food and Drug
Administration, state alcohol regulatory agencies in the states
in which the Company sells its products, and state and local
health, sanitation, safety, fire and environmental agencies. In
addition, the beer industry is subject to substantial federal
and state excise taxes, although the Company benefits from
favorable treatment granted to brewers producing less than two
million barrels per year.

Management believes that the Company currently has all licenses,
permits and approvals necessary for its current operations.
However, existing permits or licenses could be revoked if the
Company failed to comply with the terms of such permits or
licenses. Additional permits or licenses could be required in
the future for the Companys existing or expanded
operations. If licenses, permits or approvals necessary for the
Companys brewery or pub operations were unavailable or
unduly delayed, or if any such permits or licenses were revoked,
the Companys ability to conduct its business could be
substantially and adversely affected.

Both of the Companys breweries and pubs are subject to
licensing and regulation by a number of governmental
authorities. The Company operates its breweries under federal
licensing requirements imposed by the TTB. The TTB requires the
filing of a Brewers Notice upon the
establishment of a commercial brewery. In addition, commercial
brewers are required to file an amended Brewers Notice
every time there is a material change in the brewing process or
brewing equipment, change in the brewerys location, change
in the brewerys management or a material change in the
brewerys ownership. The Companys operations are
subject to audit and inspection by the TTB at any time.

In addition to the regulations imposed by the TTB, the
Companys breweries are subject to various regulations
concerning retail sales, pub operations, deliveries and selling
practices in states in which the Company sells its products.
Failure of the Company to comply with applicable federal or
state regulations could result in limitations on the
Companys ability to conduct its business. TTB permits can
be revoked for failure to pay taxes, to keep proper accounts, to
pay fees, to bond premises, to abide by federal alcoholic
beverage production and distribution regulations, or if holders
of 10% or more of the Companys equity securities are found
to be of questionable character. Permits from state regulatory
agencies can be revoked for many of the same reasons.

The U.S. federal government currently imposes an excise tax
of $18 per barrel on beer sold for consumption in the
U.S. However, any brewer with annual production under two
million barrels instead pays federal excise tax in the amount of
$7 per barrel on sales of the first 60,000 barrels. While
the Company is not aware of any plans by the federal government
to reduce or eliminate this benefit to small brewers, any such
reduction in a material amount could have an adverse effect on
the Company. In addition, the Company would lose the benefit of
this rate structure if it exceeded the two million barrel
production threshold. Individual states also impose excise taxes
on alcoholic beverages in varying amounts, which have also been
subject to

change. It is possible that excise taxes will be increased in
the future by both the federal government and several states. In
addition, increased excise taxes on alcoholic beverages have in
the past been considered in connection with various governmental
budget-balancing or funding proposals. Any such increases in
excise taxes, if enacted, could adversely affect the Company.

The Companys brewery operations are subject to
environmental regulations and local permitting requirements and
agreements regarding, among other things, air emissions, water
discharges and the handling and disposal of wastes. While the
Company has no reason to believe the operations of its
facilities violate any such regulation or requirement, if such a
violation were to occur, or if environmental regulations were to
become more stringent in the future, the Company could be
adversely affected.

The serving of alcoholic beverages to a person known to be
intoxicated may, under certain circumstances, result in the
server being held liable to third parties for injuries caused by
the intoxicated customer. The Companys pubs have addressed
this concern by establishing early closing hours and regularly
scheduled employee training. Large uninsured damage awards
against the Company could adversely affect the Companys
financial condition.

The Company has obtained U.S. trademark registrations for
its numerous products including its proprietary bottle design.
Trademark registrations generally include specific product
names, marks and label designs. The Redhook mark and certain
other Company marks are also registered in various foreign
countries. The Company regards its Redhook and other trademarks
as having substantial value and as being an important factor in
the marketing of its products. The Company is not aware of any
infringing uses that could materially affect its current
business or any prior claim to the trademarks that would prevent
the Company from using such trademarks in its business. The
Companys policy is to pursue registration of its marks in
its markets whenever possible and to oppose vigorously any
infringement of its marks.

At December 31, 2007, the Company had 221 employees,
including 67 in production, 113 in the pubs, 25 in sales
and marketing, and 16 in administration. Of these, 2 in
production, 76 in the pubs and 1 in administration and were
part-time employees. The Company believes its relations with its
employees to be good.

Item 1A.

Risk
Factors

The risks described below, together with all of the other
information included in this report, should be carefully
considered in evaluating our business and prospects. The risks
and uncertainties described herein are not the only ones facing
us. We operate in a market environment that is difficult to
predict and that involves significant risks, many of which are
beyond our control. If any of the events, contingencies,
circumstances or conditions described in the following risks
actually occur, our business, financial condition or results of
operations could be seriously harmed. If that happens, the
trading price of our Common Stock could decline and you may lose
part or all of the value of any shares held by you. Solely for
purposes of the risk factors in this Item 1A., the terms
we, our and us refer to
Redhook Ale Brewery, Incorporated.

We are dependent upon our continuing relationship with
Anheuser-Busch, Incorporated. Substantially all
of our products will be sold and distributed through the A-B
Distribution Agreement and through Craft Brands. Craft Brands
distributes Redhook products through a separate distribution
arrangement with A-B. If our relationship with A-B, our
relationship with Craft Brands or the relationship between A-B
and Craft Brands were to deteriorate, distribution of our
products would suffer significant disruption and such event
would have a long-term severe negative impact on our sales and
results of operations, as it would be extremely difficult for us
to rebuild our own distribution network. In such an event, we
would be faced with finding another

national distribution partner similar to A-B, and entering into
a complex distribution and investment arrangement with that
entity, or with negotiating separate distribution agreements
with individual distributors throughout the U.S. Currently,
Redhook distributes its product through a network of more than
560 independent wholesale distributors, most of whom are
geographically contiguous and independently owned and operated,
and 13 branches owned and operated by A-B. If we had to
negotiate separate agreements with individual distributors, such
an undertaking would necessarily take a significant amount of
time to complete, during which our products would not be
distributed. It would also be extremely difficult to build a
seamless and contiguous distribution network similar to the one
we currently enjoy through A-B. Additionally, we would need to
raise significant capital to fund the development of a new
distribution network and continue operations. There can be no
guarantee that financing would be available when needed, either
from our current lender or from the capital markets, or that any
such financing would be on commercially reasonable terms. Given
the difficulty that we would face if we needed to rebuild our
distribution network, if the current distribution arrangement
with A-B were to be terminated, it is unlikely Redhook would be
able to continue as a going concern. We believe that the
benefits of the A-B Distribution Agreement and our relationship
with A-B and Craft Brands, in particular the distribution and
material cost efficiencies, offset the costs associated with the
relationship. However, there can be no assurance that these
costs will not have a negative impact on our sales and results
of operations in the future.

Our agreement with A-B contains limitations on our ability to
engage in or reject certain transactions, including acquisitions
and changes of control. The Exchange and
Recapitalization Agreement with A-B contains limitations on our
ability to take certain actions without the prior consent of
A-B, or without offering to A-B a right of first refusal,
including the following:



issuing equity securities;



acquiring or selling assets or stock;



amending our Articles of Incorporation or bylaws;



granting board representation rights;



entering into certain transactions with affiliates;



distributing our products in the U.S. other than through
A-B, Craft Brands or as provided in the A-B Distribution
Agreement;



distributing or licensing the production of any malt beverage
product in any country outside of the U.S.;



voluntarily delisting or terminating our listing on the Nasdaq
Stock Market; or



disposing of any of our interest in Craft Brands.

Additionally, A-B has the right to terminate the Distribution
Agreement in the event any competitor of
A-B acquires
more than 10% of the outstanding common stock of Redhook.

Further, if the A-B Distribution Agreement is terminated, or the
distribution of Redhook products is terminated by Craft Brands,
A-B has the right to solicit and negotiate offers from third
parties to purchase all or substantially all of the assets or
securities of Redhook or to enter into a merger or consolidation
transaction with our Company and the right to cause our board of
directors to consider any such offer.

The practical effect of the foregoing restrictions is to grant
to A-B the ability to veto certain transactions that management
may believe to be in the best interest of Redhook and our
shareholders, including expansion of the Company through
acquisitions of other craft brewers or new brands, merger with
other brewing companies or distribution of Redhook products
outside the U.S. As a result, the results of operations and
the trading price of our Common Stock may be adversely affected.

A-Bs ownership of our Common Stock may allow A-B to
exercise significant control and influence over our
Company. As of December 31, 2007 and 2006,
A-B owned approximately 33.1% and 33.3%, respectively, of our
Common Stock and, under the Exchange and Recapitalization
agreement, has the right to appoint two designees to our board
of directors. As a result, A-B may be able to exercise
significant control

and influence over the Company and matters requiring approval of
our shareholders, including the election of directors and
approval of significant corporate transactions, such as a merger
or other sale of our company or its assets. This could limit the
ability of other shareholders to influence corporate matters and
may have the effect of delaying or preventing a third party from
acquiring control of the Company. In addition, A-B may have
actual or potential interests that diverge from the rest of our
shareholders. The securities markets may also react unfavorably
to A-Bs ability to control certain matters involving our
Company, which could have a negative impact on the trading price
of our common stock.

Our investment in Craft Brands Alliance LLC may not provide
anticipated benefits. We believe that Craft
Brands combined sales and marketing organization creates
synergies and capitalizes on both Redhooks and
Widmers sales and marketing experience and complementary
product portfolios. We have realized a decrease in selling,
general and administrative expenses when compared to levels
prior to the formation of Craft Brands and we have recognized
income of $2,826,000 in 2007, $2,655,000 in 2006 and $2,392,000
in 2005 from our investment in Craft Brands. However, Craft
Brands has only been operational since July 2004 and predicting
future benefits from Crafts Brands is difficult. There can be no
assurance that we will see any further or anticipated benefits
from the joint venture. Shipments of our products in the Western
Territory have declined since the formation of Craft Brands;
2007 shipments were approximately 7.5% lower than 2004 shipments
in the same territory and approximately 0.6% lower than 2006
shipments. Pricing of our products has increased and the level
of promotion and discounting has declined, allowing us to
achieve higher revenue per barrel. However, management believes
there is a direct correlation to lower sales caused by higher
net pricing. During this same period, Craft Brands has been very
successful selling the Widmer and Kona products. Although we
enjoy the benefits of those successes through our profit-sharing
arrangement with Craft Brands, we believe it is critical for
Craft Brands to deliver success with the Redhook products in
addition to the other products. We have communicated this
concern to Craft Brands, and we are working with Craft Brands to
establish new brand management throughout the portfolio of
Redhook products. Craft Brands also responded to this concern by
re-emphasizing their commitment to Redhook products and focusing
its sales efforts on our Long Hammer IPA. Although this
attention has resulted in an increase in shipments of Long
Hammer IPA in 2007 over 2006 levels, shipments of other Redhook
products in the Western Territory have not shown similar
improvement. We continue to work with Craft Brands management to
improve performance. If Craft Brands is unable to increase
shipments of our products in the west, our operations will
become more dependent on lower margin contract brewing and
profit margins will suffer.

The Operating Agreement requires us to make certain capital
contributions to support the operations of Craft
Brands. In 2004, we made a sales and marketing
capital contribution to Craft Brands in the amount of $250,000.
The Operating Agreement designated this sales and marketing
capital contribution be used by Craft Brands for expenses
related to the marketing, advertising and promotion of Redhook
products. In February 2007 and in February 2008, we entered into
an amendment to the Operating Agreement to require an additional
sales and marketing contribution in 2009 if the volume of sales
of Redhook products in 2008 in the Craft Brands territory is
less than 92% of the volume of sales of Redhook products in 2003
in the Craft Brands territory. Under these amendments, our
maximum 2009 sales and marketing contribution was reduced to
$310,000, reflecting our commitment to expand the production
capacity of our Washington and New Hampshire breweries to
produce more Widmer products. Widmer also has a sales and
marketing contribution under the amended Operating Agreement
with similar terms that is capped at $750,000. If required, the
2009 sales and marketing contribution is due by February 1,
2009. Because sales in the craft beer industry generally reflect
a degree of seasonality and we have historically operated with
little or no backlog, our ability to predict sales for future
periods is limited. Accordingly, we cannot predict to what
degree, if at all, we will be required to make this 2009 sales
and marketing contribution. If we are required to make this
additional sales and marketing contribution in 2009, our
available cash will decrease and income from Craft Brands will
decrease by the amount of the contribution, which will be
allocated 100% to us. The Operating Agreement also obligates us
and Widmer to make other additional capital contributions only
upon the request and consent of the Craft Brands board of
directors.

The proposed Merger with Widmer Brothers Brewing Company may
not occur, and failure to complete the transaction may have a
negative impact on our stock price or our future business and
financial results. On

November 13, 2007, we entered into the Merger Agreement
with Widmer, pursuant to which Widmer will merge with and into
Redhook. In connection with the merger, each holder of shares of
common or preferred stock of Widmer will receive, in exchange
for each share held, 2.1551 shares of our Common Stock.
Redhook security holders will continue to own their existing
shares of Redhook Common Stock. The shares of Redhook Common
Stock that Widmer security holders will be entitled to receive
pursuant to the merger are expected to represent approximately
50% of the outstanding shares of the combined company
immediately following the consummation of the merger (assuming
that no security holder of Widmer exercises dissenters
rights in connection with the merger, and that currently
outstanding options held by our employees, officers, directors
and former directors to acquire shares of Redhook Common Stock
are not exercised prior to the consummation of merger). The
merger is subject to customary conditions to closing, including
regulatory approval, approval of A-B, approval by our
shareholders of the issuance of the shares of Common Stock
issuable in the merger and approval of the merger by the
requisite vote of Widmer shareholders. If the merger with Widmer
is not completed for any reason, our business may be adversely
affected and will be subject to a number of risks, including:



failure to pursue other beneficial opportunities as a result of
the focus of management on the merger, without realizing any of
the anticipated benefits of completing the transaction;



the market price of our Common Stock might decline; and



our costs related to the merger, such as legal and accounting
fees, which total approximately $738,000 through
December 31, 2007, must be paid even if the merger is not
completed.

In addition, if the Merger Agreement is terminated and our board
of directors decides to pursue another business combination,
there can be no assurance that it will be able to find a partner
willing to provide equivalent or more attractive consideration
than the consideration to be provided in the merger.

Additionally, our current employees may experience uncertainty
about their future as employees of the combined company until
strategies with regard to the combined company are announced or
executed. This may adversely affect our ability to attract and
retain key personnel, and may affect their performance during
the period of uncertainty. We have attempted to address this
concern through the adoption of a Company-wide severance plan
that requires the payment of six months of severance benefits to
all full-time employees, other than executive officers, in the
event an employee is terminated as a result of a combination
with Widmer. We have also entered into amended employment
agreements and severance arrangements with several of our
executive officers which provide for severance payments to such
officers upon termination of employment. However, these
severance arrangements may not be sufficient to adequately
address employee concerns.

We are dependent on our distributors for the sale of our
products. Although substantially all of our
products will be sold and distributed through A-B and Craft
Brands, we continue to rely heavily on distributors, most of
which are independent wholesalers, for the sale of our products
to retailers. K&L is responsible for distribution of our
products in one of our largest markets  Seattle,
Washington. K&L accounted for approximately 8%, 11% and 12%
of total sales volume in 2007, 2006 and 2005, respectively. A
disruption of our ability, or the ability of Craft Brands, the
wholesalers, or A-B to distribute products efficiently due to
any significant operational problems, such as wide-spread labor
union strikes, the loss of K&L as a customer, or the
termination of the A-B Distribution Agreement or the Craft
Brands Supply and Distribution Agreement could hinder our
ability to get our products to retailers and could have a
material adverse impact on our sales and results of operations.

Changes in state laws regarding distribution arrangements may
adversely impact our operations. In 2006, the
Washington State legislature passed a bill that removes the
long-standing requirement that small producers of wine and beer
distribute their products through wholesale distributors, thus
permitting these small producers to distribute their products
directly to retailers. The law further provides that any
in-state or out-of-state brewery that produces more than
2,500 barrels annually may distribute its products directly
to retailers if it does so from a facility located in the state
that is physically separate and distinct from its production
facilities. The new legislation stipulates that prices charged
by a brewery must be uniform to all distributors and retailers,
but does not restrict prices retailers may charge consumers.
While it is too soon to predict what

impact, if any, this law will have on our operations, the beer
and wine market may experience an increase in competition and
cause our future sales and results of operations to be adversely
affected. This law may also impact the financial stability of
Washington State wholesalers on which we rely.

Increased competition could adversely affect sales and
results of operations. We compete in the highly
competitive craft brewing market as well as in the much larger
specialty beer market, which encompasses producers of import
beers, major national brewers that produce fuller-flavored
products, and large spirit companies and national brewers that
produce flavored alcohol beverages. Beyond the beer market,
craft brewers also face competition from producers of wines and
spirits. Primarily as a result of this increased competition, we
have experienced inconsistent sales results. From 1997 through
1999, our sales volumes declined. From 2000 to 2003 we
experienced annual increases in shipments, excluding shipments
of beer brewed on a contract basis, but experience a deline in
shipments again in 2004. Although we have seen annual increases
in shipments since 2004, these increases have been modest
compared to the performance of the craft brewing segment as a
whole. Increasing competition could cause our future sales and
results of operations to be adversely affected. We have
historically operated with little or no backlog and, therefore,
our ability to predict sales for future periods is limited.

Future price promotions to generate demand for our products
may be unsuccessful. Future prices that we charge
for our products may decrease from historical levels, depending
on competitive factors in our various markets. In order to
stimulate demand for our products, we have participated in price
promotions with our wholesalers and retail customers in most of
our markets. The number of markets in which we participate in
price promotions and the frequency of such promotions may
increase in the future. There can be no assurance however that
our price promotions will be successful in increasing demand for
our products.

Due to our concentration of sales in the Pacific Northwest,
our results of operations and financial condition are subject to
fluctuations in regional economic conditions. A
significant portion of our sales continue to be in the Pacific
Northwest region and, consequently, our business may be
adversely affected by changes in economic and business
conditions nationally and, particularly, within the Northwest
region. We believe this region is also one of the most
competitive craft beer markets in the U.S., both in terms of
number of market participants and consumer awareness. We believe
that the Pacific Northwest offers significant competition to our
products, not only from other craft brewers but also from the
growing wine market and from flavored alcohol beverages. We face
extreme competitive pressure in Washington State which is our
largest and oldest market. Since 2003, we have experienced a
decline in sales volume in Washington State of approximately
18.5%.

The competition that we face in the Pacific Northwest is
magnified because our brand is viewed as being relatively
mature. Focus studies in late 2004 indicated that, while our
brand possesses brand awareness among target consumers, it also
appears to not attract key consumers who seem to be more
interested in experimenting with new products. These focus
studies have resulted in Craft Brands focusing its marketing
efforts over the past several years on updating the Redhook
brand image to stimulate demand. Despite these efforts, sales in
the Pacific Northwest continued to decline in 2006 and 2007.
Craft Brands has informed us that they are committed to
addressing this negative trend in the western territory, but
there can be no assurance that Craft Brands will be successful
in increasing shipments and sales of Redhook product. If
shipments of our products in the highly competitive Pacific
Northwest markets do not increase, our market share and profit
margins will continue to suffer.

Our business is seasonal in nature, and we are likely to
experience fluctuations in our results of operations and
financial condition. Sales of our products are
somewhat seasonal, with the first and fourth quarters
historically being the slowest and the rest of the year
generating stronger sales. As well, our sales volume may also be
affected by weather conditions. Therefore, our results for any
quarter may not be indicative of the results that may be
achieved for the full fiscal year. If an adverse event such as a
regional economic downturn or poor weather conditions should
occur during the second and third quarters, the adverse impact
to our revenues would likely be greater as a result of our
seasonal business.

Our gross margins may fluctuate while our expenses remain
constant. We anticipate that our future gross
margins will fluctuate and may even decline as a result of many
factors, including shipments to Craft

Brands at a fixed price substantially below wholesale pricing
levels, disproportionate depreciation and other fixed and
semivariable operating costs, and the level of production at our
breweries in relation to current production capacity. Our high
level of fixed and semivariable operating costs causes gross
margin to be especially sensitive to relatively small increases
or decreases in sales volume. In addition, other factors beyond
our control that could affect cost of sales include changes in
freight charges, the availability and prices of raw materials
and packaging materials, the mix between draft and bottled
product sales, the sales mix of various bottled product
packages, and federal or state excise taxes.

An increase in lower margin contract brewing could negatively
impact our overall profit margins. In connection
with our Supply and Distribution Agreement with Craft Brands, if
shipments of Redhook products in the western territory decrease
as compared to the previous years shipments, we have the
contractual right to brew Widmer products in an amount equal to
the lower of (i) our product shipment decrease or
(ii) the Widmer product shipment increase. We refer to this
contractual right as our Contractual Obligation. In 2007, we
brewed and shipped 3,500 barrels of Widmer beer from our
Washington Brewery under this Contractual Obligation. At
Widmers discretion, we may also brew more beer for Widmer
than the Contractual Obligation amount pursuant to a
Manufacturing and Licensing Agreement with Widmer. Our
Manufacturing and Licensing Agreement with Widmer expires on
December 31, 2008. In 2007, we brewed and shipped
78,400 barrels of Widmer product under this agreement.
Driven by the Contractual Obligation, as well as Widmers
production needs, we anticipate that contract brewing in 2008
will decrease over 2007 levels. Contract brewing has lower
margins compared to sales of Redhook products.

We are dependent on contract brewing to keep our production
facilities operating at an efficient capacity; a decrease in
contract brewing could have an unfavorable and significant
financial impact on our financial statements and results of
operations. Widmer has notified us that they will
be bringing additional brewing capacity on line in the first
half of 2008, which will significantly reduce our level of
contract brewing for Widmer out of our Washington Brewery. We
are currently evaluating alternatives to utilize the capacity
that will become available upon the termination of the contract
brewing, including entering into new contract brewing
arrangements with other parties. If we are unable to replace the
Widmer contract brewing, or achieve significant growth through
our own products, the resulting loss of revenue and the
resulting excess capacity and unabsorbed overhead in the
Washington Brewery would have an adverse effect on our financial
performance.

Changes in consumer preferences or public attitudes about our
products could reduce demand. If consumers were
unwilling to accept our products, or if general consumer trends
caused a decrease in the demand for beer, including craft beer,
it would adversely impact our sales and results of operations.
If the flavored alcohol beverage market, the wine market, or the
spirits market continues to grow, they could draw consumers away
from our products and have an adverse effect on our sales and
results of operations. Further, the alcoholic beverage industry
has become the subject of considerable societal and political
attention in recent years due to increasing public concern over
alcohol-related social problems, including drunk driving,
underage drinking and health consequences from the misuse of
alcohol. If beer consumption in general were to come into
disfavor among domestic consumers, or if the domestic beer
industry were subjected to significant additional governmental
regulation, our operations could be adversely affected.

We are subject to governmental regulations affecting our
breweries and pubs; the costs of complying with governmental
regulations, or our failure to comply with such regulations,
could affect our financial condition and results of
operations. Our breweries and our pubs are
subject to licensing and regulation by a number of governmental
authorities, including the U.S. Treasury Department,
Alcohol and Tobacco Tax and Trade Bureau, or the TTB, the
U.S. Department of Agriculture, the U.S. Food and Drug
Administration, state alcohol regulatory agencies in the states
in which we sell our products, and state and local health,
sanitation, safety, fire and environmental agencies. Our failure
to comply with applicable federal, state or local regulations
could result in limitations on our ability to conduct business.
TTB permits can be revoked for failure to pay taxes, to keep
proper accounts, to pay fees, to bond premises, to abide by
federal alcoholic beverage production and distribution
regulations, or if holders of 10% or more of our equity
securities are found to be of questionable character. TTB
permits are also required in connection with establishing a
commercial brewery, expanding or modifying existing brewing
operations, entering into a contract brewing arrangement, and
entering into an

alternating brewery agreement. Other permits or licenses can be
revoked if we fail to comply with the terms of such permits or
licenses, and additional permits or licenses could be required
in the future for our existing or expanded operations. If
licenses, permits or approvals necessary for our brewery or pub
operations were unavailable or unduly delayed, or if any such
permits or licenses were revoked, our ability to conduct
business could be substantially and adversely affected.

Our brewery operations are also subject to environmental
regulations and local permitting requirements and agreements
regarding, among other things, air emissions, water discharges,
and the handling and disposal of wastes. We have no reason to
believe the operations of our facilities violate any such
regulation or requirement. However, if such a violation were to
occur, or if environmental regulations became more stringent in
the future, our business could be adversely affected.

We are also subject to dram shop laws, which
generally provide a person injured by an intoxicated person the
right to recover damages from an establishment that wrongfully
served alcoholic beverages to the intoxicated person. Our pubs
have addressed this concern by establishing early closing hours
and regularly scheduled employee training. However, large
uninsured damage awards against our Company could adversely
affect our financial condition.

We may experience material losses in excess of insurance
coverage. We believe that we maintain insurance
coverage that is customary for businesses of our size and type.
There are, however, certain types of catastrophic losses that
are not generally insured because it is not economically
feasible to insure against such losses. Should an uninsured loss
or a loss in excess of insured limits occur, such loss could
have an adverse effect on our results of operations and
financial condition.

Declining sales trends could adversely affect brewery
efficiency and our financial results. Our
breweries have been operating at production levels substantially
below their current and maximum designed capacities. Operating
our breweries at low capacity utilization rates negatively
impacts our gross margins and operating cash flows generated by
the production facilities. We periodically evaluate whether we
expect to recover the costs of our production facilities over
the course of their useful lives. If facts and circumstances
indicate that the carrying value of these long-lived assets may
be impaired, we will perform an evaluation of recoverability in
accordance with FASB Statement of Financial Accounting Standards
No. 144, Accounting for the Impairment or Disposal of
Long-Lived
Assets. This evaluation will encompass a comparison of the
carrying value of the assets to a projection of future
undiscounted cash flows from the assets in addition to an
analysis of other quantitative and qualitative factors. If our
management believes that the carrying value of such assets may
not be recoverable, we will recognize an impairment loss by a
charge against current operations.

An increase in excise taxes could adversely affect our
financial condition. The U.S. federal
government currently imposes an excise tax of $18 per barrel on
beer sold for consumption in the U.S. However, any brewer
with annual production under two million barrels instead pays
federal excise tax in the amount of $7 per barrel on sales
of the first 60,000 barrels. While we are not aware of any
plans by the federal government to reduce or eliminate this
benefit to small brewers, any such reduction in a material
amount could have an adverse effect on our financial condition
and results of operations. In addition, we would lose the
benefit of this rate structure if we exceeded the two million
barrel production threshold. Individual states also impose
excise taxes on alcoholic beverages in varying amounts, which
have also been subject to change. It is possible that excise
taxes will be increased in the future by both federal and state
governments in connection with various governmental
budget-balancing or funding proposals or for other reasons. Any
such increases in excise taxes, if enacted, could adversely
affect our financial condition.

We may experience a shortage in kegs necessary to distribute
draft beer. We distribute our draft beer in kegs
that are owned by us as well as leased from A-B and a
third-party vendor. During periods when we experience stronger
sales, we may need to rely on kegs leased from A-B and the
third-party vendor to address the additional demand. If
shipments of draft beer increase, we may experience a shortage
of available kegs to fill sales orders. If we cannot meet our
keg requirements through either lease or purchase, we may be
required to delay some draft shipments. Such delays could have
an adverse impact on sales and relationships with wholesalers
and A-B. In addition, we may decide to pursue other alternatives
for leasing or purchasing kegs. There is no assurance, though,
that we will be successful in securing additional kegs.

Our key raw materials may become significantly more costly
and adequate supplies may be difficult to
secure. According to industry and media sources,
the price of barley, a primary ingredient in most of our beers,
increased 48% from August 2006 through June 2007. The
significant price increase is apparently driven by a lower
supply of barley as farmers shift their focus to growing corn, a
key component of biofuels. While we have historically utilized
fixed price contracts to secure adequate supplies of key raw
materials, including barley, recent fixed price contracts
reflect current market pricing that is significantly higher than
historical pricing. In addition to a decline in the supply of
barley, the beer industry also appears to be experiencing a
decline in the supply of hops driven by a number of factors,
including: excess supply in the 1990s led some growers to switch
to more lucrative crops, resulting in an estimated 40% decrease
in worldwide hop-growing acreage; poor weather in eastern Europe
and Germany caused substantial hops crop losses in 2007; hops
crop production in England has declined approximately 85% since
the mid-1970s; and 2007 U.S., New Zealand, and Australia hops
crop yields were only average. On average, we have experienced
cost increases of approximately 27%, 1%, and 8% for 2008
purchases of malted barley, hops, and wheat, respectively. We
estimate that these higher raw materials costs will result in an
increase in 2008 cost of sales of approximately $3.23 per
barrel. If our 2008 production levels remained unchanged from
2007 levels, our cost of sales will likely increase by
approximately $1,030,000 for the full year. If we experience
difficulty in securing our key raw materials or continue to
experience increases in the cost of these materials, it will
have a material impact on our gross margins and results of
operations. We have also entered into fixed price purchase
contracts for our specialty hops, both to assure the necessary
supply for current and future production needs, but also to
obtain favorable pricing. However, if we experience difficulty
in securing key raw materials or experience an increase in the
cost of these materials, our gross margins and results of
operations will be negatively affected.

Loss of income tax benefits could negatively impact results
of operations. As of December 31, 2007, our
Companys deferred tax assets were primarily comprised of
federal net operating loss carryforwards, which we refer to as
NOLs, of $24.7 million, or $8.4 million tax-effected;
federal and state alternative minimum tax credit carryforwards
of $185,000; and state NOL carryforwards of $196,000
tax-effected. We may be unable to realize these deferred tax
assets before they expire. Accordingly, we established a
valuation allowance in 2002, increased it further in 2003, 2004,
and 2005 and decreased it in 2006 to cover certain federal and
state NOLs that may expire before we are able to utilize the tax
benefit. As of December 31, 2007 and 2006, we had a
valuation allowance of $1,059,000. The valuation allowance
reduces the benefit of our deferred tax asset on our balance
sheet. To the extent that we continue to be unable to generate
adequate taxable income in future periods, we will not be able
to recognize additional tax benefits and may be required to
record a greater valuation allowance covering potentially
expiring NOLs.

The loss of the services of certain key personnel could have
a material adverse effect on operations. We
depend on the services of our key management personnel,
including Paul Shipman, our chief executive officer, and David
Mickelson, our president. If we lose the services of any members
of our senior management or key personnel for any reason, we may
be unable to replace them with qualified personnel, which could
have a material adverse effect on our operations. Additionally,
the loss of Paul Shipman as our chief executive officer, and our
failure to find a replacement satisfactory to A-B, would be a
default under the A-B Distribution Agreement. We do not carry
key person life insurance on any of our executive officers.

Litigation risks could have a material adverse effect on our
financial condition and operations. At any given
time, we are subject to claims and actions incidental to the
operation of our business. The outcome of these proceedings
cannot be predicted. If a plaintiff were successful in a claim
against our Company, we could be faced with the payment of a
material sum of money. If this were to occur, it could have an
adverse effect on our financial condition.

Our common stock price could be subject to significant
fluctuations
and/or may
decline. The market price of our common stock
could be subject to significant fluctuations. Among the factors
that could affect our stock price are:

changes in estimates or recommendations by securities analysts,
if any, who cover our common stock



future sales of our common stock;



variations in our operating results;



changes in the market values of public companies that operate in
our business segment;



general market conditions; and



domestic economic factors unrelated to our performance.

The stock markets in general have recently experienced
volatility that has sometimes been unrelated to the operating
performance of particular companies. These broad market
fluctuations may cause the trading price of our common stock to
decline.

Item 1B.

Unresolved
Staff Comments

None.

Item 2.

Properties

The Company currently operates two highly automated small-batch
breweries, one in the Seattle suburb of Woodinville, Washington
and the other in Portsmouth, New Hampshire. See Notes 5 and
11 to the Financial Statements included elsewhere herein.

The Washington Brewery. The Washington
Brewery, located on approximately 22 acres (17 of which are
developable) in Woodinville, Washington, a suburb of Seattle, is
across the street from the Chateau Ste. Michelle Winery, next to
the Columbia Winery and visible from a popular bicycle path. The
Washington Brewery is comprised of an approximately
88,000 square-foot building, a 40,000 square-foot
building and an outdoor tank farm. The two buildings house a
100-barrel
brewhouse, fermentation cellars, filter rooms, grain storage
silos, a bottling line, a keg filling line, dry storage, two
coolers and loading docks. The brewery includes a retail
merchandise outlet and the Forecasters Public House, a
4,000 square-foot family-oriented pub that seats 200 and
features an outdoor beer garden that seats an additional 200.
Additional entertainment facilities include a
4,000 square-foot special events room accommodating up to
250 people. The brewery also houses office space, a portion
of which is occupied by the Companys corporate office and
the remainder of which is leased through October 2009. The
Company purchased the land in 1993 and believes that its value
has appreciated. The brewerys theoretical production
capacity as of year end 2007 is approximately
250,000 barrels per year, which would be under ideal
brewing conditions. An example of ideal brewing conditions would
be brewing one particular flavor seven days a week during the
whole year with minimal filtration loss. The theoretical
production capacity in 2007 is also expected to be approximately
250,000 barrels per year.

The New Hampshire Brewery. The New Hampshire
Brewery is located on approximately 23 acres in Portsmouth,
New Hampshire. The land is subleased, the term of which expires
in 2047, and contains two seven-year extension options. The New
Hampshire Brewery is modeled after the Washington Brewery and is
similarly equipped, but is larger in design, covering
125,000 square feet to accommodate all phases of the
Companys brewing operations under one roof. Also included
is a retail merchandise outlet, the Cataqua Public House, a
4,000 square-foot family-oriented pub with an outdoor beer
garden, and a special events room accommodating up to
250 people. Production began in late October 1996, with an
initial brewing capacity of approximately 100,000 barrels
per year. In order to accommodate anticipated sales growth,
additional brewing capacity was installed in 2002, 2003, 2006
and 2007, bringing the total theoretical production capacity as
of year end 2007 to approximately 235,000 barrels per year.
The Company has the ability to phase in additional brewing
capacity as needed, up to the maximum designed production
capacity of approximately 250,000 barrels per year under
ideal brewing conditions.

The Company is involved from time to time in claims, proceedings
and litigation arising in the normal course of business. The
Company believes that, to the extent that any pending or
threatened litigation involving the Company or its properties
exists, such litigation will not likely have a material adverse
effect on the Companys financial condition or results of
operations.

Mr. Shipman is one of the Companys founders and has
served as the Companys Chairman of the Board since
November 1992 and Chief Executive Officer since June 1993. From
September 1981 to November 2005, Mr. Shipman served as the
Companys President. Prior to founding the Company,
Mr. Shipman was a marketing analyst for the Chateau Ste.
Michelle Winery from 1978 to 1981. Mr. Shipman received his
Bachelors degree in English from Bucknell University in
1975 and his Masters degree in Business Administration
from the Darden Business School, University of Virginia, in
1978. Since July 2004, Mr. Shipman has served as a director
of Craft Brands.

If the proposed merger with Widmer is consummated,
Mr. Shipman will cease to be Chief Executive Officer and a
director, but he will serve as Chairman Emeritus and be
available to provide services as a consultant to the
Companys board of directors for a term of approximately
one year.

Mr. Mickelson has served as President of the Company since
December 2005 and Chief Operating Officer since March 1995. From
December 2005 until March 2007, he also served as Chief
Financial Officer. From August 2000 through November 2005,
Mr. Mickelson served as Executive Vice President and Chief
Financial Officer. From April 1994 to March 1995, he was the
Companys Vice President and General Manager. From July
1992 to December 1994, he served as its Chief Financial Officer,
and was also named General Manager in January 1994. He served as
the Companys Controller from 1987 to July 1992, and
additionally was elected Treasurer in 1989. From 1985 to 1987,
he was the Controller for Certified Foods, Inc. and from 1981 to
1985, he served as a loan officer with Barclays Bank PLC.
Mr. Mickelson received his Bachelors degree in
Business Administration from the University of Washington in
1981.

Mr. Prial has served as the Companys Vice President,
Sales and Eastern Operations since December 2005. Mr. Prial
served as Vice President, East Coast Operations from November
2001 through November 2005. From 1996 to November 2001,
Mr. Prial served as the General Manager of the
Companys New Hampshire Brewery. He served as the
Companys Southern California Field Sales Manager from
August 1994 to March 1996. From April 1993 to April 1994,
Mr. Prial served as Vice President of Sales for Brewski
Brewing Company of Culver City, California. From 1979 to 1993,
he served in various positions for Wisdom Import Sales Company
in Irvine, California. From 1977 to 1979, Mr. Prial worked
for the Miller Brewing Company as an Area Manager in the Pacific
Northwest. He received his Bachelors degree in Management
and Economics from Marietta College in Marietta, Ohio in 1977.

In February 2008, Mr. Prial resigned as Vice President,
Sales and Eastern Operations of the Company. Mr. Prial is
expected to continue his employment with the Company to assist
with sales and business development through August 31, 2008.

Mr. Triplett has served as Vice President, Brewing since
March 1995. From 1987 to March 1995, he was the Companys
Production Manager. He has worked in virtually every facet of
production since joining the Company in 1985. Mr. Triplett
has taken coursework at the Siebel Institute of Brewing and the
University of California at Davis. He is a member of the Master
Brewers Association of America and is currently serving as its
Vice President in the Northwest district and formerly as its
Secretary and Treasurer. He is also a member of the American
Society of Brewing Chemists and a past and founding board member
of National Ambassadors at the University of Wyoming. He
received his Bachelors degree in Petroleum Engineering
from the University of Wyoming in 1985.

In February 2008, Mr. Triplett resigned as Vice President,
Brewing of the Company. Mr. Triplett is expected to
continue his employment with the Company to assist production
and brewing operations through June 30, 2008.

Mr. Caldwell has served as the Companys Chief
Financial Officer and Treasurer since March 2007. From June 2006
until March 2007, Mr. Caldwell was the Companys
Controller, Treasurer and Principal Accounting Officer. During
the first half of 2006, he performed financial consulting for
Captaris, Inc. in Bellevue, Washington. From 2001 to 2005,
Mr. Caldwell served as the General Manager of Arena Sports
in Redmond, WA, where his primary responsibilities were running
all aspects of retail arena operations. From 1997 to 2003, he
owned Caldwell Resource Group, a consulting firm focused on
evaluating acquisitions and negotiating service contracts in the
telecommunications industry. Since beginning his career as a CPA
with Haskins & Sells in 1977, Mr. Caldwell has
also served in high level finance and accounting roles with
manufacturing and software companies.

It is anticipated that, following the closing of the proposed
merger with Widmer, the combined company accounting and
information systems functions will be relocated to Portland,
Oregon and a new Chief Financial Officer will be appointed.
Mr. Caldwell is expected to continue his employment with
the Company through August 15, 2008.

There is no family relationship between any of the directors or
executive officers of the Company.

The Companys Common Stock trades on the Nasdaq Stock
Market under the trading symbol HOOK. The table below sets
forth, for the fiscal quarters indicated, the reported high and
low sale prices of the Companys Common Stock, as reported
on the NASDAQ Stock Market:

As of March 14, 2008, there were 673 Common Stockholders of
record, although the Company believes that the number of
beneficial owners of its Common Stock is substantially greater.

The Company has not paid any dividends since 1994. The Company
anticipates that for the foreseeable future, all earnings, if
any, will be retained for the operation and expansion of its
business and that it will not pay cash dividends. The payment of
dividends, if any, in the future will be at the discretion of
the board of directors and will depend upon, among other things,
future earnings, capital requirements, restrictions in future
financing agreements, the general financial condition of the
Company and general business conditions.

Comparative
Performance Graph

Set forth below is a graph comparing the cumulative total return
to shareholders on the Companys Common Stock with the
cumulative total return of the Russell 2000 Index and an index
comprised of other publicly-traded craft beer companies (the
Peer Group) for the period beginning on
December 31, 2002 and ended on December 31, 2007. The
total return on the Companys Common Stock, the Russell
2000 Index and the Peer Group Index assumes the value of each
investment was $100 on December 31, 2002, and that any
dividends were reinvested. The points represent fiscal year-end
index levels based on the last trading day in each fiscal year.
Return information is historical and not necessarily indicative
of future performance.

2002

2003

2004

2005

2006

2007

Redhook

$

100

$

126

$

171

$

154

$

253

$

323

Peer Group Index

$

100

$

136

$

166

$

190

$

254

$

268

Russell 2000 Index

$

100

$

145

$

170

$

176

$

215

$

200

The Companys Peer Group is comprised of three publicly
traded craft beer companies. As required, the returns of each of
the component companies in the Peer Group Index are calculated
and weighted according to their respective market capitalization
at the beginning of the period. The Peer Group is composed of:
Big Rock Brewery Income Trust (formerly Big Rock Brewery Ltd.)
(Toronto Stock Exchange: BR.UN-T); The Boston Beer Company, Inc.
(NYSE: SAM); and Pyramid Breweries Inc. (NASDAQ: PMID).

The following selected financial data should be read in
conjunction with the Companys Financial Statements and the
Notes thereto and Managements Discussion and Analysis
of Financial Condition and Results of Operations included
elsewhere in this
Form 10-K.
The selected statement of operations and balance sheet data for,
and as of the end of, each of the five years in the period ended
December 31, 2007, are derived from the financial
statements of the Company. The operating data are derived from
unaudited information maintained by the Company.

Based on the Companys estimate of theoretical production
capacity of brewing equipment, assuming ideal brewing
conditions, in service as of the end of such period. Amounts do
not reflect maximum designed production capacity. See
Managements Discussion and Analysis of Financial
Condition and Results of Operations.

(2)

Includes term loan and capital lease obligations. See
Note 7 to the Financial Statements included elsewhere
herein.

Managements
Discussion and Analysis of Financial Condition and Results of
Operations

The following discussion and analysis should be read in
conjunction with the Companys Financial Statements and
Notes thereto included herein. The discussion and analysis
includes period-to-period comparisons of the Companys
financial results. Although period-to-period comparisons may be
helpful in understanding the Companys financial results,
the Company believes that they should not be relied upon as an
accurate indicator of future performance.

Since its formation, the Company has focused its business
activities on the brewing, marketing and selling of craft beers
in the U.S. The Company produces its specialty bottled and
draft products in two Company-owned breweries, one in the
Seattle suburb of Woodinville, Washington and the other in
Portsmouth, New Hampshire. Prior to July 1, 2004, the
Companys sales consisted predominantly of sales of beer to
third-party distributors and A-B through the Companys
Distribution Alliance with A-B. Since July 1, 2004, the
Companys sales consisted of sales of product to Craft
Brands and A-B. The Company and Widmer manufacture and sell
their product to Craft Brands at a price substantially below
wholesale pricing levels; Craft Brands, in turn, advertises,
markets, sells and distributes the product to wholesale outlets
in the western U.S. through a distribution agreement
between Craft Brands and A-B. (Due to state liquor regulations,
the Company sells its product in Washington State directly to
third-party beer distributors and returns a portion of the
revenue to Craft Brands based upon a contractually determined
formula.) Profits and losses of Craft Brands are generally
shared between the Company and Widmer based on the cash flow
percentages of 42% and 58%, respectively. The Company continues
to sell its product in the midwest and eastern U.S. through
sales to A-B pursuant to the July 1, 2004 A-B Distribution
Agreement. For additional information regarding Craft Brands and
the A-B Distribution Agreement, see Item 1., Product
Distribution  Relationship with Anheuser-Busch,
Incorporated and  Relationship with Craft Brands
Alliance LLC. See also  Results of Operations
 Craft Brands Alliance LLC  below. In
addition to sales of beer, the Company derives other revenues
from sources including the sale of retail beer, food, apparel
and other retail items in its two brewery pubs.

For the year ended December 31, 2007, the Company had gross
sales and a net loss of $46,544,000 and $939,000, respectively,
compared to gross sales and net income of $40,007,000 and
$516,000, respectively, for the year ended December 31,
2006. As of December 31, 2007, the net amount due from A-B
was $1,098,000. As of December 31, 2006, the net amount due
to A-B was $247,000.

The Companys sales volume (shipments) increased 16.7% to
316,900 barrels in 2007 as compared to 271,600 barrels
in 2006. Sales in the craft beer industry generally reflect a
degree of seasonality, with the first and fourth quarters
historically being the slowest and the rest of the year
typically demonstrating stronger sales. The Company has
historically operated with little or no backlog, and its ability
to predict sales for future periods is limited.

The Companys sales are affected by several factors,
including consumer demand, price discounting and competitive
considerations. The Company competes in the highly competitive
craft brewing market as well as in the much larger specialty
beer market, which encompasses producers of import beers, major
national brewers that produce fuller-flavored products, and
large spirit companies and national brewers that produce
flavored alcohol beverages. Beyond the beer and flavored alcohol
markets, craft brewers also face competition from producers of
wines and spirits. The craft beer segment is highly competitive
due to the proliferation of small craft brewers, including
contract brewers, and the large number of products offered by
such brewers. Imported products from foreign brewers have
enjoyed resurgence in demand since the mid-1990s. Certain
national domestic brewers have also sought to appeal to this
growing demand for craft beers by producing their own
fuller-flavored products. In recent years, the specialty segment
has seen the introduction of flavored alcohol beverages, the
consumers of which, industry sources generally believe,
correlate closely with the consumers of the import and craft
beer products. Sales of these flavored alcohol beverages were
initially very strong, but growth rates have slowed in
subsequent years. While there appears to be fewer participants
in this category than at its peak, there is still significant
volume associated with these beverages. The wine and spirits
market has also experienced a surge in the past several years,
attributable to competitive pricing, increased merchandising,
and increased consumer interest in wine and spirits. Because the
number of participants and

number of different products offered in this segment have
increased significantly in the past ten years, the competition
for bottled product placements and especially for draft beer
placements has intensified.

The Company is required to pay federal excise taxes on sales of
its beer. The excise tax burden on beer sales increases from $7
to $18 per barrel on annual sales over 60,000 barrels and
thus, if sales volume increases, federal excise taxes would
increase as a percentage of sales.

Under normal circumstances, the Company operates its brewing
facilities up to seven days per week with multiple shifts per
day. Under ideal brewing conditions (which would include, among
other factors, production of a single brand in a single
package), the theoretical production capacity is approximately
250,000 barrels per year at the Washington Brewery and
235,000 barrels per year at the New Hampshire Brewery.
Because of various factors, including the following two, the
Company does not believe that it is likely that actual
production volume will approximate theoretical production
capacity: (1) the Companys brewing process, which
management believes is similar to its competitors brewing
processes, inherently results in some level of beer loss
attributable to filtering, bottling, and keg filling; and
(2) the Company routinely brews and packages various brands
and package sizes during the year.

In order to accommodate volume growth in the markets served by
the New Hampshire Brewery, the Company has expanded fermentation
capacity during the last several years. In May 2007, the Company
completed process control automation upgrades to the brewery and
added one 70,000 pound grain silo. In June 2007, the Company
completed the installation of four additional
400-barrel
fermenters. Installation cost for this expansion totaled
$1.3 million and added approximately 25,000 barrels of
capacity to the New Hampshire Brewery, bringing the
brewerys theoretical production capacity to approximately
235,000 barrels per year. As with the previous expansions,
production capacity at the New Hampshire Brewery can be added in
phases until the facility reaches its maximum designed
production capacity of approximately 250,000 barrels per
year, under ideal brewing conditions. Driven by various
considerations including seasonality, production schedules of
various draft products and bottled products and packages, and
losses attributable to filtering, bottling and keg filling,
actual production capacity will be less than theoretical
production capacity. In order to reduce the spread between
actual and theoretical production capacity, additional capital
expenditures will be required. The decision to add capacity is
affected by the availability of capital, construction
constraints and anticipated sales in new and existing markets.

The Companys capacity utilization has a significant impact
on gross profit. Generally, when facilities are operating at
their maximum designed production capacities, profitability is
favorably affected because fixed and semi-variable operating
costs, such as depreciation and production salaries, are spread
over a larger sales base. Because current period production
levels have been below the Companys current production
capacity, gross margins have been negatively impacted. This
negative impact could be reduced if actual production increases.

In addition to capacity utilization, other factors that could
affect cost of sales and gross margin include sales to Craft
Brands at a price substantially below wholesale pricing levels,
sales of contract beer at a pre-determined contract price,
changes in freight charges, the availability and prices of raw
materials and packaging materials, the mix between draft and
bottled product sales, the sales mix of various bottled product
packages, and fees related to the A-B Distribution Agreement.

For additional information about risks and uncertainties facing
the Company, see Item 1A. Risk Factors above.

On November 13, 2007, the Company entered into an Agreement
and Plan of Merger (the Merger Agreement) with
Widmer Brothers Brewing Company, an Oregon corporation
(Widmer), pursuant to which Widmer will merge with
and into Redhook, and each outstanding share of capital stock of
Widmer (other than any dissenting shares entitled to statutory
appraisal rights under Oregon law) will be converted into the
right to receive 2.1551 shares of Redhook Common Stock. The
merger will result in Widmer shareholders and existing Redhook
shareholders each holding approximately 50% of the outstanding
shares of the combined company

(assuming that no Widmer shareholder exercises statutory
appraisal rights and that currently outstanding options held by
Redhook employees, officers, directors and former directors to
acquire share of Redhook Common Stock are not exercised prior to
consummation of the merger). In connection with the merger, the
Company will change its name to Craft Brewers Alliance,
Inc.

The Company and Widmer have made customary representations,
warranties and covenants in the Merger Agreement, including,
among others, a covenant by the Company to cause a meeting of
Redhook shareholders to be held to approve issuance of the
shares of Common Stock issuable in the merger. The merger is
subject to customary conditions to closing, including
(i) regulatory approval from the Alcohol and Tobacco Tax
and Trade Bureau and state licensing agencies,
(ii) approval of Anheuser-Busch, Incorporated,
(iii) approval by the requisite vote of Redhook
shareholders of the issuance of the shares of Common Stock
issuable in the merger, (iv) approval of the merger by the
requisite vote of Widmer shareholders, (v) accuracy of the
representations and warranties made by the parties under the
Merger Agreement, (vi) compliance by the parties with their
covenants, and (vii) the absence of any material adverse
change to either Redhook or Widmer.

The Merger Agreement was filed as Exhibit 2.1 to the
Companys current report on
Form 8-K
filed on November 13, 2007.

In connection with the discussions leading up to the Merger
Agreement, the Company has incurred approximately $738,000 in
legal, consulting, meeting and severance costs during the year
ended December 31, 2007, respectively. Of the total,
approximately $584,000 is reflected in the statement of
operations as selling, general and administrative expenses and
$154,000 has been capitalized, reflected as other current assets
in the balance sheet, in accordance with FASB Statement of
Financial Accounting Standards (SFAS) No. 141,
Business Combinations.

The Company adopted a Company-wide severance plan that requires
the payment of severance benefits to all full-time employees,
other than executive officers, in the event that an employee is
terminated as a result of a merger or other business combination
with Widmer. The Company is also party to employment
arrangements with its executive officers which provide for
severance payments to such officers upon termination of
employment. If the proposed merger with Widmer is consummated,
the Company anticipates that the integration of the finance,
accounting and information technology functions of Redhook and
Widmer will result in such functions, including the Chief
Financial Officer position held by Mr. Caldwell, no longer
being performed by the Redhook finance, accounting and
information technology departments. In addition,
Mr. Shipman will cease to be Chief Executive Officer, and
Mr. Prial and Mr. Triplett will leave the Company. The
Company estimates that severance benefits totaling approximately
$2.0 million will be paid to all affected employees
including executive officers in connection with the successful
closing of the proposed merger.

The following table sets forth a comparison of sales (in
dollars) for the periods indicated:

Sales for the Year Ended

December 31,

Increase /

2007

2006

(Decrease)

% Change

A-B

$

18,879,182

$

17,158,964

$

1,720,218

10.0

%

Craft Brands

13,884,725

13,953,208

(68,482

)

(0.5

)

Contract brewing

7,363,214

3,264,120

4,099,094

125.6

International and non-wholesalers

87,588

108,902

(21,314

)

(19.6

)

Pubs and other

6,328,792

5,521,514

807,278

14.6

Total shipped

$

46,543,501

$

40,006,708

$

6,536,794

16.3

%

Sales. Total sales increased $6,537,000 in
2007 compared to 2006, primarily impacted by the following
factors:



An increase in pricing and an increase in shipments in the
midwest and eastern U.S. resulted in a $1,942,000 increase
in 2007 sales;



An overall decrease in pricing and an overall decrease in
shipments in the western U.S. (not including beer brewed on
a contract basis) resulted in a $68,000 decrease in sales in
2007;



An increase in shipments of beer brewed on a contract basis,
slightly offset by a decrease in pricing of these shipments,
contributed to a $4,099,000 increase in sales in 2007; and



An increase of $807,000 in pub and other sales in 2007.

Shipments. The following table sets
forth a comparison of shipments (in barrels) for the periods
indicated:

Year Ended December 31,

2007

2006

Draft

Bottle

Total

Draft

Bottle

Total

Increase /

Shipments

Shipments

Shipments

Shipments

Shipments

Shipments

(Decrease)

% Change

A-B

46,100

61,800

107,900

44,600

56,800

101,400

6,500

6.4

%

Craft Brands

35,300

86,600

121,900

37,200

85,400

122,600

(700

)

(0.6

)

Contract brewing

48,300

33,600

81,900

43,000



43,000

38,900

90.5

Pubs and other

3,900

1,300

5,200

3,400

1,200

4,600

600

13.0

Total shipped

133,600

183,300

316,900

128,200

143,400

271,600

45,300

16.7

%

Total Company shipments increased 16.7% in 2007 as compared to
2006, primarily driven by a substantial increase in shipments of
beer brewed on a contract basis. Total 2007 sales volume
increased to 316,900 barrels from 271,600 barrels in
2006. Shipments of the Companys packaged products
increased 27.8% while shipments of the Companys draft
products increased 4.2%. Excluding the impact of shipments of
beer brewed on a contract basis, the Companys shipments of
bottled beer have steadily increased as a percentage of total
beer shipments since the mid-1990s. In 2007, 63.7% of
total shipments, excluding beer brewed under a contract brewing
arrangement, were shipments of bottled beer versus 62.7% in 2006.

Contributing significantly to the 45,300 barrel increase in
the Companys total shipments is an increase of
38,900 barrels of beer brewed under contract brewing
arrangements with Widmer. In connection with the Supply,
Distribution and Licensing Agreement with Craft Brands, if
shipments of the Companys products in the Craft Brands
territory decrease as compared to the previous years
shipments, the Company has the right to brew Widmer products in
an amount equal to the lower of (i) the Companys
product shipment decrease or (ii) the Widmer product
shipment increase (the Contractual Obligation). In
addition, pursuant to a Manufacturing and Licensing Agreement
with Widmer, the Company may, at Widmers request, brew
more

beer for Widmer than the Contractual Obligation. This
Manufacturing and Licensing Agreement with Widmer, as amended,
expires on December 31, 2008. Under these contract brewing
arrangements, the Company brewed and shipped 81,900 barrels
and 43,000 barrels of Widmer beer in 2007 and 2006,
respectively. Of these shipments, approximately 96% of the
2007 barrels were in excess of the Contractual Obligation
and 77% of the 2006 barrels were in excess of the
Contractual Obligation. Through 2006, these contract brewing
arrangements were limited to brewing draft beer at the
Washington Brewery. However, the Company began brewing and
shipping packaged beer from the Washington Brewery during the
first quarter of 2007 and the New Hampshire Brewery began
brewing and shipping draft beer during the second quarter of
2007. During 2007, approximately 41% of the 81,900 barrels
shipped was packaged product and approximately
4,400 barrels of the total 81,900 barrels shipped was
brewed and shipped by the New Hampshire Brewery. The
Company does not anticipate that the New Hampshire Brewery will
be utilized in conjunction with the contract brewing arrangement
with Widmer in future periods. Excluding shipments under these
contract brewing arrangements, 2007 shipments of the
Companys draft and bottled products increased modestly, or
2.8%, as compared to 2006. Driven by the Contractual Obligation
as well as Widmers production needs, the Company
anticipates that beer brewed and shipped in 2008 under the
contract brewing arrangements with Widmer will be lower than
2007 levels. The Company is evaluating alternatives to utilize
the capacity that will become available, if the proposed merger
with Widmer does not close, upon the termination of the contract
brewing arrangement. If the Company is unable to achieve
significant growth through its own products or other alternative
products, the Company may have significant unabsorbed overhead
that would generate unfavorable financial results.

Included in the Companys total shipments (as shipments
through A-B in the table above) are shipments of Widmer
Hefeweizen, a golden unfiltered wheat beer that is one of
the leading American style Hefeweizens sold in the U.S. The
Company brews Widmer Hefeweizen at the New Hampshire
Brewery and distributes the beer through A-B in the midwest and
eastern U.S. under license from Widmer. In 2003, the
Company entered into a licensing agreement with Widmer to
produce and sell the Widmer Hefeweizen brand in states
east of the Mississippi River. In March 2005, the Widmer
Hefeweizen distribution territory was expanded to include
all of the Companys midwest and eastern markets. In the
fourth quarter of 2006, the Widmer Hefeweizen
distribution territory was again modified when Widmer
exercised its contractual right to eliminate Texas from the
Companys Widmer Hefeweizen distribution territory.
The licensing agreement automatically renewed on
February 1, 2008 for an additional one-year term expiring
February 1, 2009. The agreement provides for additional
one-year automatic renewals unless either party notifies the
other of its desire to have the agreement expire at the end of
the then existing term at least 150 days prior to such
expiration. The agreement may also be terminated by either party
at any time without cause pursuant to 150 days notice or
for cause by either party under certain conditions.
Additionally, Redhook and Widmer have entered into a secondary
agreement providing that if Widmer terminates the licensing
agreement or causes it to expire before December 31, 2009,
Widmer will pay the Company a lump sum payment to partially
compensate the Company for capital equipment expenditures made
at the New Hampshire Brewery to support Widmers growth.
During the term of this agreement, the Company will not brew,
advertise, market, or distribute any product that is labeled or
advertised as a Hefeweizen or any similar product in
the agreed upon midwest and eastern territory. Brewing and
selling of Redhooks Hefe-weizen was discontinued in
conjunction with this agreement. The Company shipped
28,800 barrels and 30,600 barrels of Widmer
Hefeweizen in 2007 and 2006, respectively. The Company
believes that this agreement increases capacity utilization and
has strengthened the Companys product portfolio. If the
Widmer licensing agreement were terminated, the Company would
evaluate alternatives to utilize the excess capacity, either
through new and existing Redhook products or alternative brewing
relationships. If the Company is unable to utilize the capacity,
the loss of revenue and the resulting excess capacity in the New
Hampshire Brewery would have an adverse effect on the
Companys financial performance.

Excluding shipments of beer brewed under the contract brewing
arrangement with Widmer and under the Widmer Hefeweizen
licensing agreement, total Company shipments in the
U.S. increased nearly 8,100 barrels, or 4.1% in 2007
as compared to 2006.

During 2007 and 2006, the Companys products were
distributed in 48 states. Shipments in the midwest and
eastern United States increased by 6.4% compared to 2006 while
shipments in the western United States served by Craft Brands
decreased 0.6% during 2007 as compared to 2006.

Sales to Craft Brands in 2007 represented 38% of total
shipments, or 121,900 barrels, compared to 45%, or
122,600 barrels in 2006. Comparing 2007 to 2003, shipments
of Redhook products in the Craft Brands territory have declined
15.8% and shipments in Washington state, the Companys
largest and oldest market, have declined 16.3%. In addition,
consumer and retailer demand for Redhook branded products has
lagged the demand for Widmer and Kona products in the Craft
Brand territory in recent years. Beginning in 2004, Craft Brands
initiated a five-year plan to strengthen the Redhook brand by
improving the volume trend through targeted distribution growth,
systematic pricing increases to enhance perceived value and
bolster brand profitability, and focused marketing programs to
attract and retain Redhook drinkers. Since these efforts were
initiated, the Redhook brand sales trends in the Craft Brands
territory has shown a slowing in the rate of decline and,
recently, some growth. In 2004, the brand experienced an 8%
decline over 2003 shipments the Craft Brands territory. In 2005,
2006 and 2007, the year over year losses were 4%, 3% and 1%,
respectively. The improvement in shipments in the Craft Brands
territory was driven by a reversal of the negative trend in
Washington state. Shipments of the Redhook brand declined 12% in
2004 in Washington when compared to 2003, 2% in 2005 when
compared to 2004, and 5% in 2006 when compared to 2005. In 2007,
though, shipments in Washington increased 2% over 2006. In
Washington state, Redhook has been a market leader for many
years and has in-market pricing that is consistent with other
top selling craft brands. Consequently, management believes that
the trend reversal is more likely a result of additional focus
in the form of distribution drives and brand awareness programs
and less likely a result of pricing.

In 2007, Colorado, Hawaii and New Mexico reported double digit
declines in shipments of Redhook product. In select markets,
including Colorado, Hawaii and New Mexico, Redhook had
historically elected to price its products below the market
leaders. Over the past four years, Craft Brands has
systematically raised Redhooks in-market pricing to levels
comparable to the market leaders. This strategy is intended to
strengthen the perceived value of the Redhook brand over the
long term. However, in the short term, it is expected that
Redhook may continue to experience volume declines in certain
markets.

In addition to strengthening the perceived value of the Redhook
brand, Craft Brands management has focused on enhancing value
through re-branding efforts and this is achieving some positive
results. Craft Brands initiative to re-brand Redhook
IPA into Long Hammer IPA has resulted in positive
momentum for the Companys fastest growing national brand.
Management at Craft Brands recognizes this effort is necessary
and is reviewing packaging and marketing campaign changes that
are expected to be introduced in 2008 and 2009 to build on the
Long Hammer IPA success.

Different products within brand families go through different
life cycles at different times. Although Redhook ESB has
historically been a larger percentage of Redhooks volume,
the Company has experienced a decline in shipments of this
product over the last five years as this product has matured.
Long Hammer IPA has now become the Companys primary
growth product and its growth has more than offset the loss of
Redhook ESB volume in the last two years. During the same
five-year period that Redhook shipments declined in the Craft
Brands territory, sales of Kona and Widmer products have
increased. Kona is a relatively new product, recently introduced
into many of the states served by Craft Brands. Although this
product has experienced the rapid growth of a new brand that
benefits from growing distribution and new trial from consumers,
it is still much smaller in volume than the Redhook or Widmer
brands. The growth experienced by the Widmer brand during this
five-year period has been led by the popular consumer response
to the Hefeweizen category within the craft beer segment and the
role Widmer Hefeweizen has enjoyed in being a leader in
this category. This category continues to experience very
positive trends nationally, but in recent years has seen a
significant increase in competitive products from other craft
brewers as well as offerings from large domestic brewers
attempting to participate in the same category.

In the eastern half of the United States serviced by the Redhook
sales force, the Redhook brand growth has been fueled by
increased distribution led by the growth of Long Hammer
IPA. The craft beer market in the

east has not been as developed as in the west until recently and
Redhook has benefited from increased interest in the category,
the re-branding efforts described above and its strong
distribution network.

Sales in the midwest and eastern United States in 2007
represented approximately 34% of total shipments, or
107,900 barrels, compared to 37%, or 101,400 barrels
in 2006. Contributing most significantly to the sales growth in
2007 were increased sales to states in the southeastern U.S.,
offset by declines in sales in several New England and
midwestern states.

Pricing and Fees. The Company sells its
product at wholesale pricing levels in the midwest and eastern
U.S., at lower than wholesale pricing levels to Craft Brands in
the western U.S., and at
agreed-upon
pricing levels for beer brewed on a contract basis.

The Company continues to sell its product at wholesale pricing
levels in the midwest and eastern U.S. through sales to
A-B. Average wholesale revenue per barrel for draft products,
net of discounts, improved more than 4% in 2007 compared to
2006. This increase in pricing accounted for an increase of
approximately $254,000 in total sales. Average wholesale revenue
per barrel for bottle products, net of discounts, increased
nearly 4% in 2007 compared to 2006. This increase in pricing
accounted for an increase of approximately $444,000 in total
sales. Management believes that most, if not all, craft brewers
are reviewing their pricing strategies in response to recent
increases in the costs of raw materials and the weak dollar.
Seldom, if ever, have pricing changes in recent years been
driven by an inflationary period. Instead, pricing changes
implemented by the Company have generally followed pricing
changes initiated by large domestic or import brewing companies.
While the Company has implemented modest price increases during
the past few years, some of the benefit has been offset by
competitive promotions and discounting. The Company may
experience a decline in sales in certain regions following a
price increase.

The Company sells its product to Craft Brands at a price
substantially below wholesale pricing levels pursuant to the
Supply, Distribution and Licensing Agreement with Craft Brands;
Craft Brands, in turn, advertises, markets, sells and
distributes the product to wholesale outlets in the western
U.S. through a distribution agreement between Craft Brands
and A-B. The prices that the Company charges for draft product
and for bottled product are determined by contractually defined
formulas and are based on the twelve month average pricing
ending September of the previous year for all Redhook and Widmer
draft and bottled product sold by Craft Brands. The prices are
adjusted on January 1st of each year. Average revenue
per barrel for draft products sold to Craft Brands increased
nearly 2% in 2007 compared to 2006. This increase in pricing
accounted for an increase of approximately $60,000 in total
sales. Average revenue per barrel for bottle products sold to
Craft Brands decreased nearly 1% in 2007 compared to 2006
resulting in a decrease of $95,000 in total sales.

Average revenue per barrel on beer brewed on a contract basis
for Widmer pursuant to the Supply, Distribution and Licensing
Agreement with Craft Brands is generally at a price
substantially lower than wholesale pricing levels. After the
Contractual Obligation has been fulfilled pursuant to the
Supply, Distribution and Licensing Agreement with Craft Brands,
the price charged Widmer for any additional barrels brewed
declines pursuant to the Manufacturing and Licensing Agreement
with Widmer, as amended. Average revenue per barrel for draft
beer brewed on a contract basis decreased approximately 4% in
2007 compared to 2006 resulting in a decrease of $132,000 in
total sales. In the first quarter of 2007, the Company began
shipping bottled beer under this contract brewing arrangement.

In connection with all sales through the July 1, 2004 A-B
Distribution Agreement, the Company pays a Margin fee to A-B.
The Margin does not apply to sales from the Companys
retail operations or to dock sales. The Margin also does not
apply to the Companys sales to Craft Brands because Craft
Brands pays a comparable fee to A-B on its resale of the
product. The A-B Distribution Agreement also provides that the
Company shall pay the Additional Margin on shipments that exceed
shipments in the same territory during fiscal 2003. During the
year ended December 31, 2007, the Margin was paid to A-B on
shipments totaling 107,900 barrels to 532 distribution points.
During the year ended December 31, 2006, the Margin was
paid to A-B on shipments totaling 101,400 barrels to 503
distribution points. Because 2007 and 2006 shipments in the
midwest and eastern U.S. each exceeded 2003 shipments in
the same territory, the Company paid A-B the

Additional Margin on 30,000 and 23,000 barrels,
respectively. The Margin is reflected as a reduction of sales in
the Companys statements of operations.

Retail Operations and Other
Sales. Sales through the Companys
retail operations and other sales increased $807,000 to
$6,329,000 in 2007 from $5,522,000 in 2006, primarily as the
result of an increase in beer and food sales.

Excise Taxes. Excise taxes increased $781,000
to $5,074,000 for 2007 compared to $4,292,000 for 2006,
primarily as a result of the overall increase in shipments. The
Company continues to be responsible for federal and state excise
taxes for all shipments, including those to Craft Brands and
brewed under contract. The comparability of excise taxes as a
percentage of net sales is impacted by: average revenue per
barrel; the mix of sales in the midwest and eastern United
States, sales to Craft Brands, sales of beer brewed on contract
basis, and pub sales; and the estimated annual average federal
and state excise tax rates.

Cost of Sales. Cost of sales is comprised of
direct and overhead costs incurred to produce the Companys
package and draft products, as well as expenses associated with
the Companys pub operations. Comparing 2007 to 2006, cost
of sales increased by $5,867,000, increased as a percentage of
net sales and increased on a per barrel basis. The increase in
cost of sales was driven by an increase in the production of
lower margin beer brewed on a contract basis, an increase in the
cost of some raw materials and packaging materials, a higher
proportion of packaged product, and an increase in production
losses.

In 2007, the Company shipped an additional 38,900 barrels
of beer brewed on a contract basis. In addition to the overall
increase in shipments of contract beer, approximately 41% of the
2007 shipments were packaged product while 2006 shipments were
entirely draft product.

Redhook experienced a 4% increase, or $2.10 per barrel, in the
cost of packaging compared to 2006 costs. This increase,
assuming no change in the mix of package versus draft sales,
resulted in an increase in cost of sales of approximately
$300,000. This per barrel cost increase was compounded by an
increase in 2007 year-to-date shipments of packaged product
relative to total shipments. Shipments of packaged product,
excluding shipments of beer brewed on a contract basis,
increased to 63.7% of total shipments in 2007 from 62.6% in
2006. In 2007, the gross margin on wholesale shipments of
bottled product was approximately 37% while the gross margin on
wholesale shipments of draft product was approximately 57%. Even
though average revenue per barrel, net of excise taxes, on
shipments of bottled product is generally 40% to 50% higher than
average revenue per barrel on shipments of draft product, the
2007 gross profit per barrel for bottled product was lower
than the 2007 gross profit per barrel for draft product.
Because wholesale sales price increases have not increased at
the same rate as packaging costs have increased in recent years,
the 2007 gross profit per barrel for bottled product has
been negatively impacted. If wholesale pricing does not increase
at the rate of packaging cost increases, the Companys
gross profit and results of operations will be negatively
impacted.

According to industry and media sources, the price of barley, a
primary ingredient in most beers, has increased 48% over the
past 18 months. The significant price increase is
apparently driven by a lower supply of barley as farmers shift
their focus to growing corn, a key component of biofuels. While
the Company has experienced an increase in the cost of barley
over the past year, the Companys fixed price contracts had
limited that increase through August 2007 to less than 10%. The
Companys existing barley purchase contracts expired during
the third quarter of 2007; the Companys new barley supply
contracts reflect current market pricing that is significantly
higher than the pricing in the expired contracts. In addition to
a decline in the supply of barley, the beer industry appears to
also be experiencing a decline in the supply of hops, driven by
a number of factors: excess supply in the 1990s led some growers
to switch to more lucrative crops, resulting in an estimated 40%
decrease in worldwide hop-growing acreage; poor weather in
eastern Europe and Germany caused substantial hops crop losses
in 2007; hops crop production in England has declined
approximately 85% since the mid-1970s; and 2007 U.S., New
Zealand, and Australia hops crop yields were only average. As
with malted barley, the Company has fixed price purchase
contracts for its specialty hops, both to assure that the
Company will have the necessary supply for current and future
production needs, but also to obtain favorable pricing. In 2007
and early 2008, the Company entered into fixed price purchase
contracts for the Companys key specialty hops; the Company
believes that these contracts will provide a substantial portion
of the requirements for this hop for the next five years. While
the cost of these hops is significantly higher in some

cases than the Companys cost in prior years, management
believes that securing an adequate supply is crucial in the
current environment. On average, Redhook experienced cost
increases of approximately 51%, 16% and 1% for 2007 purchases of
malted barley, wheat and hops, respectively. These increases in
the cost of malted barley, wheat and hops resulted in an
increase in 2007 cost of sales of approximately $5.20 per
barrel. At 2006 production levels, these raw material cost
increases resulted in an increase in cost of sales of
approximately $1,415,000. If the Company experiences difficulty
in securing its key raw materials or continues to experience
increases in the cost of these materials, it will have a
material impact on the Companys gross margins and results
of operations. The Company will continue to seek opportunities
to secure favorable pricing for its key materials.

The Companys cost of sales includes a licensing fee of
$432,000 and $437,000 for 2007 and 2006, respectively, in
connection with the Companys shipment of
28,800 barrels and 30,600 barrels of Widmer
Hefeweizen in the midwest and eastern United States pursuant
to a licensing agreement with Widmer.

Additionally, cost of sales for 2006 reflect a payment of
$124,000 from A-B for invoice costs collected by A-B from 1994
through 2005 in excess of amounts due under the 1994 A-B
Distribution Alliance and the 2004 A-B Distribution Agreement.

Based upon the breweries combined theoretical production
capacity under optimal year-round brewing conditions of
475,000 barrels and 445,000 barrels for 2007 and 2006,
the utilization rates were 67% and 61%, respectively. Capacity
utilization rates are calculated by dividing the Companys
total shipments by the combined theoretical production capacity.

Selling, General and Administrative
Expenses. Selling, general and administrative
expenses for 2007 increased $1,993,000 to $8,841,000 from
expenses of $6,848,000 for 2006. The increase is primarily
attributable to costs related to the proposed merger with
Widmer, salaries and related expense, sales and marketing
expenditures, costs associate with Sarbanes-Oxley and SEC
compliance, and stock-based compensation expense. In 2007, the
Company incurred approximately $738,000 in legal, consulting,
meeting and severance costs in connection with the merger
discussions. Of the total, approximately $584,000 is reflected
in the statement of operations as selling, general and
administrative expenses, and $154,000 is attributable to
payments to third parties and has been capitalized, reflected as
other current assets in the balance sheet, in accordance with
FASB SFAS No. 141, Business Combinations.
Salaries and related expenses also increased $463,000 for 2007
as compared to 2006, and sales and marketing promotional
expenditures were up $552,000 for 2007. Driven by the 2007
requirement that management must assess and report on the
effectiveness of the Companys internal control over
financial reporting under Section 404(a) of the Sarbanes Oxley
Act of 2002, the Company incurred additional consulting and
accounting-related fees of approximately $227,000 in 2007. In
May 2007, the Company issued 24,200 shares of the
Companys Common Stock to independent, non-employee
directors and certain executive officers and recognized
stock-based compensation expense of $169,400. Stock-based
compensation expense recognized in 2006 totaled $54,000 and was
attributable to stock options granted to independent,
non-employee directors.

The Company promotes its products through a variety of
advertising programs with its wholesalers and downstream
retailers, by training and educating wholesalers and retailers
about the Companys products, through promotions and point
of sales displays at local festivals, venues, and pubs, by
utilizing its pubs located at the Companys two breweries,
through price discounting, and, more recently, through Craft
Brands. These advertising and promotional activities frequently
involve the local wholesaler sharing in the cost of the program,
as permitted by law, because management believes that these
cost-sharing arrangements align the interests of the Company
with those of the wholesaler or retailer whose local market
knowledge contributes to more effective promotions. Sharing
these efforts with a wholesaler helps the Company to leverage
its investment in advertising programs and gives the
participating wholesaler a vested interest in the programs
success. Reimbursements from wholesalers for advertising and
promotion activities are recorded as a reduction to selling,
general and administrative expenses in the Companys
statements of operations. Reimbursements for pricing discounts
to wholesalers are recorded as a reduction to sales. For 2007
and 2006, the wholesalers contribution toward these
activities totaled approximately 1.25% and 1.0% of net sales,
respectively.

Depending on the industry and market conditions, the Company may
adjust its advertising and promotional efforts in a
wholesalers market if a change occurs in a cost-sharing
arrangement.

Income from Equity Investment in Craft
Brands. After giving effect to income
attributable to the Kona brand, which was shared differently
between the Company and Widmer through 2006, the Craft Brands
operating agreement dictates that remaining profits and losses
of Craft Brands are allocated between the Company and Widmer
based on the cash flow percentages of 42% and 58%, respectively.
For 2007, the Companys share of Craft Brands net
income totaled $2,826,000 compared to $2,655,000 for 2006. Net
cash flow of Craft Brands, if any, is generally distributed
monthly to the Company based on the Companys cash flow
percentage of 42%. In 2007, the Company received cash
distributions of $2,538,000, representing its share of the net
cash flow of Craft Brands. In 2006, the Company received cash
distributions of $2,621,000.

Interest Expense. Interest expense declined
approximately $44,000 to $302,000 in 2007 from $346,000 in 2006.
A declining term loan balance and a repayment of the
$4.3 million balance in early December 2007 resulted in a
decline in interest expense.

Other Income, net. Other income, net increased
by $134,000 to $518,000 for 2007 from $384,000 for 2006,
primarily attributable to an $87,000 increase in interest income
earned on interest-bearing deposits.

Income Taxes. The Companys provision for
income taxes was a benefit of $176,000 for 2007 and an expense
of $125,000 for 2006. Both periods include a provision for
current state taxes. The tax benefit for 2007 and the expense
for 2006 are driven by pre-tax results relative to other
components of the tax provision calculation, such as the
exclusion of a portion of meals and entertainment expenses from
tax return deductions. In 2006, the Company decreased the
valuation allowance that covers net tax operating loss
carryforwards and other net deferred tax assets. The valuation
allowance covers a portion of the Companys deferred tax
assets, specifically certain federal and state NOLs that may
expire before the Company is able to utilize the tax benefit.
Realization of the benefit is dependent on the Companys
ability to generate future U.S. taxable income. To the
extent that the Company is unable to generate adequate taxable
income in future periods, the Company will not be able to
recognize additional tax benefits and may be required to record
a greater valuation allowance covering potentially expiring NOLs.

The Company has accounted for its investment in Craft Brands
under the equity method, as outlined by APB No. 18, The
Equity Method of Accounting for Investments in Common Stock.
Pursuant to APB No. 18, the Company has recorded its share
of Craft Brands net income in the Companys statement
of operations as income from equity investment in Craft Brands.
Separate financial statements for Craft Brands are included in
this Annual Report on
Form 10-K
in Part IV., Item 15. Exhibits and Financial
Statement Schedules, in accordance with
Rule 3-09
of
Regulation S-X.
The following summarizes a comparison of certain items from
Craft Brands statements of operations for the years ended
December 31, 2007 and 2006. Certain reclassifications have
been made to the prior years financial statements to
conform to the current year presentation. The effects of the
reclassifications did not affect net income or the profit
allocation.

Sales. Sales totaled $65,358,000 for 2007
compared to $58,664,000 for 2006. In addition to selling
121,900 barrels of the Companys product to
wholesalers in the western United States in 2007 and
122,600 barrels in 2006, Craft Brands also sold Widmer and
Kona products. Total Craft Brands shipments increased
approximately 5.9% in 2007 as compared to shipments in 2006.
Average wholesale revenue per barrel for all draft products sold
by Craft Brands, net of discounts, increased nearly 4% in 2007
as compared to 2006. Average wholesale revenue per barrel for
all bottle products sold by Craft Brands, net of discounts,
increased approximately 4% in 2007 as compared to 2006. For
2007, average wholesale revenue per barrel for all products sold
by Craft Brands was approximately 1% lower than average
wholesale revenue per barrel on direct sales to wholesalers by
the Company during 2007. Craft Brands also pays fees to A-B in
connection with sales to A-B that are comparable to fees paid by
the Company.

Cost of Sales. Cost of sales totaled
$44,088,000 for 2007 compared to $40,454,000 for 2006. The
increase in cost of sales over 2006 is attributable to the 5.9%
increase in shipments, an increase in prices

charged by the Company and Widmer for draft product sold to
Craft Brands, and a $1,060,000 increase in freight and logistics
costs, slightly offset by a decrease in prices charged by the
Company for bottled product sold to Craft Brands. The
disproportionate increase in freight expense was attributable to
an increase in fuel surcharges over 2006 as well as sales growth
in Craft Brands more distant markets where the freight cost per
barrel is generally higher than the average. Craft Brands
purchases product from the Company and Widmer at a price
substantially below wholesale pricing levels pursuant to the
Supply, Distribution, and Licensing Agreement between Craft
Brands and each of the Company and Widmer.

Selling, General and Administrative
Expenses. Selling, general and administrative
expenses totaled $14,559,000 for 2007 compared to $11,879,000
for 2006, reflecting all advertising, marketing and promotion
efforts for the Redhook, Widmer and Kona brands. During 2007,
sales and marketing costs increased approximately
$2.6 million, attributable to a $687,000 reduction in the
value at which Craft Brands promotional inventories are
stated, an increase in salaries resulting from the addition of
several new positions, an increase in long-term executive
bonuses, and an expansion of the use of promotional materials
and media in certain markets. Administrative expenses were
approximately $71,000 higher than in 2006.

Net Income. Net income totaled $6,728,000 for
2007 compared to $6,339,000 for 2006. The Companys share
of Craft Brands net income totaled $2,826,000 for 2007
compared to $2,655,000 for 2006. After giving effect to income
attributable to the Kona brand, which was shared differently
between the Company and Widmer through 2006, the Craft Brands
operating agreement dictates that remaining profits and losses
of Craft Brands are allocated between the Company and Widmer
based on the cash flow percentages of 42% and 58%, respectively.

Year
Ended December 31, 2006 Compared to Year Ended
December 31, 2005

The following table sets forth, for the periods indicated, a
comparison of certain items from the Companys Statements
of Operations:

Year Ended December 31,

Increase /

2006

2005

(Decrease)

% Change

Sales

$

40,006,708

$

34,520,401

$

5,486,307

15.9

%

Less excise taxes

4,292,324

3,421,494

870,830

25.5

Net sales

35,714,384

31,098,907

4,615,477

14.8

Cost of sales

30,918,137

27,543,639

3,374,498

12.3

Gross profit

4,796,247

3,555,268

1,240,979

34.9

Selling, general and administrative expenses

6,848,050

6,783,821

64,229

0.9

Income from equity investment in Craft Brands

2,655,248

2,391,936

263,312

11.0

Operating income (loss)

603,445

(836,617

)

1,440,062

172.1

Interest expense

346,455

271,460

74,995

27.6

Other income, net

384,025

125,308

258,717

206.5

Income (loss) before income taxes

641,015

(982,769

)

1,623,784

165.2

Income tax provision (benefit)

124,850

217,674

(92,824

)

42.6

Net income (loss)

$

516,165

$

(1,200,443

)

$

1,716,608

143.0

%

Sales. Total sales increased $5,487,000 in
2006 compared to 2005, impacted primarily by the following
factors:



An increase in pricing and increase in shipments in the midwest
and eastern U.S. resulted in a $3,035,000 increase in sales
in 2006;



An increase in pricing and decrease in shipments in the western
U.S. (not including beer brewed on a contract basis)
resulted in a $345,000 decrease in sales in 2006;

An increase in shipments of beer brewed on a contract basis,
partially offset by a decrease in pricing of these shipments,
contributed to a $2,483,000 increase in sales in 2006; and



Pub and other sales increased $204,000 in 2006.

The following table sets forth a comparison of sales (in
dollars) for the periods indicated:

Sales for the Year Ended December 31,

Increase /

2006

2005

(Decrease)

% Change

A-B

$

17,158,964

$

14,037,635

$

3,121,329

22.2

%

Craft Brands

13,953,208

14,298,215

(345,007

)

(2.4

)

Contract brewing

3,264,120

780,831

2,483,289

318.0

International and non-wholesalers

108,902

86,481

22,420

25.9

Pubs and other

5,521,514

5,317,239

204,275

3.8

Total shipped

$

40,006,708

$

34,520,401

$

5,486,307

15.9

%

Shipments. The following table sets
forth a comparison of shipments (in barrels) for the periods
indicated:

Year Ended December 31,

2006

2005

Draft

Bottle

Total

Draft

Bottle

Total

Increase /

Shipments

Shipments

Shipments

Shipments

Shipments

Shipments

(Decrease)

% Change

A-B

44,600

56,800

101,400

39,700

45,400

85,100

16,300

19.2

%

Craft Brands

37,200

85,400

122,600

39,900

86,600

126,500

(3,900

)

(3.1

)

Contract brewing

43,000



43,000

8,900



8,900

34,100

383.1

Pubs and other

3,400

1,200

4,600

3,500

1,300

4,800

(200

)

(4.2

)

Total shipped

128,200

143,400

271,600

92,000

133,300

225,300

46,300

20.6

%

At December 31, 2006 and 2005, the Companys products
were distributed in 48 states. Total shipments increased
21% to 271,600 barrels in 2006 from 225,300 barrels in
2005, primarily driven by a substantial increase in beer brewed
on a contract basis and an increase in shipments of Redhook
products and Widmer Hefeweizen in the midwest and eastern
U.S. Shipments of the Companys packaged products
increased 8% while shipments of the Companys draft
products increased 39%. Since the mid 1990s, the Companys
sales of bottled beer have steadily increased as a percentage of
total beer sales, excluding sales related to contract brewing.
This migration toward increasing bottled beer sales has
continued over the past two years, with 63% of total shipments,
excluding contract brewing shipments, as bottle shipments versus
62% in 2005.

Contributing significantly to the 46,300 barrel increase in
the Companys total shipments is an increase of
34,100 barrels of beer brewed at the Washington Brewery
under a contract brewing arrangement with Widmer. In connection
with the Supply and Distribution Agreement with Craft Brands, if
shipments of the Companys products in the Craft Brands
territory decrease as compared to the previous years
shipments, the Company has the right to brew Widmer products in
an amount equal to the lower of (i) the Companys
product shipment decrease or (ii) the Widmer product
shipment increase. In addition, the Company may, pursuant to a
Manufacturing and Licensing Agreement with Widmer, brew more
beer for Widmer than the Contractual Obligation. This
Manufacturing and Licensing Agreement with Widmer expires
December 31, 2007 but may be extended for an additional
one-year term. Under these contract brewing arrangements, the
Company brewed and shipped 43,000 barrels and
8,900 barrels of Widmer draft beer in 2006 and 2005,
respectively. Of these shipments, approximately 77% of
2006 barrels were in excess of the Contractual Obligation
and 20% of 2005 barrels were in excess of the Contractual
Obligation. Excluding shipments under this arrangement,
shipments of the Companys draft products increased 3% in
the 2006 and total Company shipments increased 6%. Driven by the
Contractual Obligation as well as Widmers production
needs, the Company anticipates that

beer brewed and shipped in 2007 under the contract brewing
arrangement with Widmer will increase significantly over 2006
levels. The Company expects this level of contract brewing for
Widmer to end in the first half of 2008 as Widmer brings its own
additional brewing capacity on line. The Company is evaluating
alternatives to utilize the capacity that will become available
upon the termination of the contract brewing arrangement. If the
Company is unable to achieve significant growth through its own
products or other alternative products, the Company may have
significant unabsorbed overhead that would generate unfavorable
financial results.

Also included in the Companys total shipments is Widmer
Hefeweizen brewed at the New Hampshire Brewery under a
licensing arrangement with Widmer and distributed through A-B.
Widmer Hefeweizen is a golden unfiltered wheat beer and
is one of the leading American style Hefeweizens sold in the
U.S. In 2003, the Company entered into a licensing
agreement with Widmer to produce and sell the Widmer
Hefeweizen brand in states east of the Mississippi River. In
March 2005, the Widmer Hefeweizen distribution territory
was expanded to include all of the Companys midwest and
eastern markets. Brewing of this product is conducted at the New
Hampshire Brewery under the supervision and assistance of
Widmers brewing staff to insure their brands
quality and matching taste profile. The term of this agreement
expires February 1, 2008, with additional one-year
automatic renewals unless either party notifies the other of its
desire to have the term expire at the end of the then existing
term at least 150 days prior to such expiration. The agreement
may be terminated by either party at any time without cause
pursuant to 150 days notice or for cause by either party
under certain conditions. Additionally, the Company and Widmer
have entered into a side agreement providing that if Widmer
terminates the licensing agreement or causes it to expire before
December 31, 2009, Widmer will pay the Company a lump sum
payment to partially compensate the Company for capital
equipment expenditures made at the New Hampshire Brewery to
support Widmers growth. During the term of this agreement,
the Company will not brew, advertise, market, or distribute any
product that is labeled or advertised as a
Hefeweizen or any similar product in the agreed upon
midwest and eastern territory. Brewing and selling of
Redhooks Hefe-weizen was discontinued in conjunction with
this agreement. The Company believes that the agreement
increases capacity utilization and has strengthened the
Companys product portfolio. The Company shipped
30,600 barrels and 25,600 barrels of Widmer
Hefeweizen during 2006 and 2005, respectively; these
shipments are included in the A-B and
Non-wholesalers line in the table above. If the Widmer
licensing agreement were terminated early, or if Widmer gave
notice of its election to terminate the agreement according to
its term on February 1, 2008, the Company would need to
look to replace the lost volume, either through new and existing
Redhook products or alternative brewing relationships. If the
Company is unable to replace the lost Widmer volume, the loss of
revenue and the resulting excess capacity in the New Hampshire
Brewery would have an adverse effect on the Companys
financial performance.

Excluding shipments of beer brewed under the contract brewing
arrangement with Widmer and under the Widmer Hefeweizen
licensing agreement, total Company shipments, in the U.S.,
increased by 7,200 barrels, or 4% in 2006 as compared to
2005.

Sales in 2006 to Craft Brands represented approximately 45% of
total shipments, or 122,600 barrels, compared to 56%, or
126,500 barrels in 2005. Contributing most significantly to
the decline in shipments in the western U.S. were a 7%
decline in shipments to California, a 3% decline in shipments to
Washington State, and a 14% decline in shipments to Colorado. A
significant portion of the Companys sales continue to be
in the Pacific Northwest region, which the Company believes is
one of the most competitive craft beer markets in the U.S., both
in terms of number of market participants and consumer
awareness. The Company continues to face extreme competitive
pressure in Washington State, which is not only the
Companys largest market but is also its oldest market.
From 2000 through 2006, the Company has experienced a 24%
decline in sales volume in Washington State. In 2006, sales of
the Companys products in the Craft Brands territory
declined by 3% compared to 2005. Pricing of the companys
products has increased and the level of promotion and
discounting has declined, allowing the Company to achieve higher
revenue per barrel, however, management believes there is a
direct correlation to lower sales caused by higher net pricing.
During this same period, Craft Brands has been very successful
selling the Widmer and Kona products. Although the Company
enjoys the benefits of those successes through its
profit-sharing arrangement with Craft Brands, the Company
believes it is critical for Craft Brands to deliver success with
the Redhook products in addition to the others.

The Company has communicated this concern to Craft Brands, and
is working with Craft Brands to establish new brand management
throughout the portfolio of Redhook products. Craft Brands also
responded to this concern by re-emphasizing their commitment to
Redhook products and Craft Brands has set goals and objectives
to improve performance of the Redhook products in 2007.

Pricing and Fees. The Company sells its
product at wholesale pricing levels in the midwest and eastern
U.S., at lower than wholesale pricing levels to Craft Brands in
the western U.S., and at
agreed-upon
pricing levels for beer brewed on a contract basis.

The Company continues to sell its product at wholesale pricing
levels in the midwest and eastern U.S. through sales to
A-B. Average wholesale revenue per barrel for draft products,
net of discounts, increased approximately 1% in 2006 compared to
2005. This increase in pricing accounted for an increase of
approximately $60,000 in total sales. Average wholesale revenue
per barrel for bottle products, net of discounts, increased
approximately 1% in 2006 compared to 2005. This increase in
pricing accounted for an increase of approximately $74,000 in
total sales. Seldom, if ever, are pricing changes driven by an
inflationary period. Instead, pricing changes implemented by the
Company generally follow pricing changes initiated by large
domestic or import brewing companies. While the Company has
implemented modest price increases during the past few years,
some of the benefit has been offset by competitive promotions
and discounting. Additionally, the Company may experience a
decline in sales in certain regions following a price increase.

The Company sells its product to Craft Brands at a price
substantially below wholesale pricing levels pursuant to the
Supply, Distribution and Licensing Agreement with Craft Brands;
Craft Brands, in turn, advertises, markets, sells and
distributes the product to wholesale outlets in the western
U.S. through a distribution agreement between Craft Brands
and A-B. The prices that the Company charges Craft Brands for
draft product and for bottled product are determined by
contractually defined formulas and are based on the twelve month
average pricing ending September of the previous year for all
Redhook and Widmer draft product and for all Redhook and Widmer
bottled product sold by Craft Brands. The prices are adjusted on
January 1st of each year. Average revenue per barrel
for draft products sold to Craft Brands decreased approximately
2% in 2006 compared to 2005. This decrease in pricing accounted
for a decrease of approximately $81,000 in total sales. Average
revenue per barrel for bottle products sold to Craft Brands
increased 1% in 2006 compared to 2005 resulting in an increase
of $121,000 in total sales.

Average revenue per barrel on beer brewed on a contract basis
for Widmer pursuant to the Supply, Distribution and Licensing
Agreement with Craft Brands is generally at a price
substantially lower than wholesale pricing levels. After the
Contractual Obligation has been fulfilled pursuant to the
Supply, Distribution and Licensing Agreement with Craft Brands,
the price charged Widmer for any additional barrels brewed
declines pursuant to the Manufacturing and Licensing Agreement
with Widmer. This decline in price contributed to an overall 14%
decline in price for beer brewed on a contract basis for Widmer
in 2006.

In connection with all sales through the July 1, 2004 A-B
Distribution Agreement, the Company pays a Margin fee to A-B.
The Margin does not apply to sales to the Companys retail
operations or to dock sales. The Margin also does not apply to
the Companys sales to Craft Brands because Craft Brands
pays a comparable fee to A-B on its resale of the product. The
A-B Distribution Agreement also provides that the Company shall
pay an additional fee on shipments that exceed shipments in the
same territory during fiscal 2003 (the Additional
Margin). For 2006, the Margin was paid to A-B on shipments
totaling 101,400 barrels to approximately 503 distribution
points. For 2005, the Margin was paid to A-B on shipments
totaling, 85,100 barrels to approximately 472 distribution
points. The Margin and Additional Margin is reflected as a
reduction of sales in the Companys statement of operations.

Retail Operations and Other
Sales. Sales in the Companys retail
operations and other sales increased $204,000 to $5,521,000 in
2006 from $5,317,000 in 2005, primarily the result of an
increase in special event and food sales.

Excise Taxes. Excise taxes increased $871,000
to $4,292,000 in 2006 compared to $3,421,000 in 2005, primarily
the result of the overall increase in 2006 shipments compared to
2005. The Company continues to be responsible for federal and
state excise taxes for all shipments, including those to Craft
Brands and those

brewed under contract. The comparability of excise taxes as a
percentage of net sales is impacted by average revenue per
barrel, the mix of sales in the midwest and eastern U.S., sales
to Craft Brands, sales of beer brewed on a contract basis, pub
sales, and the estimated annual average federal and state excise
tax rates.

Cost of Sales. Comparing 2006 and 2005, cost
of sales increased 12%, or $3,374,000, yet declined on a per
barrel basis. The decline on a per barrel basis is primarily
attributable to a larger sales volume in 2006 than in 2005 being
spread over approximately the same base of fixed and
semi-variable costs. The Companys fixed and semi-variable
costs included in cost of sales are depreciation, insurance,
rent on the New Hampshire Brewery, utilities, and repair and
maintenance charges.

The Companys cost of sales also includes a licensing fee
of $437,000 and $399,000 for 2006 and 2005, respectively, in
connection with the Companys shipment of 30,600 and
25,600 barrels of Widmer Hefeweizen in the midwest and
eastern U.S. pursuant to a licensing agreement with Widmer.
Shipments of Widmer Hefeweizen to states that were included in
the expanded territory in 2005 are excluded from the computation
of the licensing fee due to Widmer.

Based upon the breweries combined theoretical production
capacity under optimal year-round brewing conditions of
460,000 barrels and 375,000 barrels for 2006 and 2005,
the utilization rates were 60% for each year. Capacity
utilization rates are calculated by dividing the Companys
total shipments by the combined theoretical production capacity.

Selling, General and Administrative
Expenses. Selling, general and administrative
expenses increased $64,000 to $6,848,000 for 2006, primarily due
to an increase in salary expenses resulting from staff turnover
and a highly competitive job market for employers. Selling,
general and administrative expenses for 2006 also include
$54,000 for stock-based compensation expense incurred in the
second quarter of 2006. On January 1, 2006, the Company
adopted SFAS No. 123R, Share-Based Payment,
which requires all share-based payments to employees and
directors be recognized as expense in the statement of
operations based on their fair values and vesting periods. This
second quarter 2006 expense is solely attributable to stock
options granted to the independent members of the board of
directors in May 2006 as part of their director compensation
package. No compensation expense was recognized in 2006 for
stock options outstanding as of December 31, 2005 because
these options were fully vested prior to the January 1,
2006 adoption of SFAS No. 123R.

The Company promotes its products through a variety of
advertising programs with its wholesalers and downstream
retailers, by training and educating wholesalers and retailers
about the Companys products, through promotions and point
of sales displays at local festivals, venues, and pubs, by
utilizing its pubs located at the Companys two breweries,
through price discounting, and, more recently, through Craft
Brands. These advertising and promotional activities frequently
involve the local wholesaler sharing in the cost of the program,
as permitted by law, because management believes that these
cost-sharing arrangements align the interests of the Company
with those of the wholesaler or retailer whose local market
knowledge contributes to more effective promotions. Sharing
these efforts with a wholesaler helps the Company to leverage
its investment in advertising programs and gives the
participating wholesaler a vested interest in the programs
success. Reimbursements from wholesalers for advertising and
promotion activities are recorded as a reduction to selling,
general and administrative expenses in the Companys
statements of operations. Reimbursements for pricing discounts
to wholesalers are recorded as a reduction to sales. For 2006
and 2005, the wholesalers contribution toward these
activities totaled approximately 1.0% and 1.1% of net sales,
respectively. Depending on the industry and market conditions,
the Company may adjust its advertising and promotional efforts
in a wholesalers market if a change occurs in a
cost-sharing arrangement.

Income from Equity Investment in Craft
Brands. In accordance with the Craft Brands
operating agreement, the Company made a $250,000 sales and
marketing capital contribution to Craft Brands in 2004; the
capital contribution was used by Craft Brands for expenses
related to the marketing, advertising, and promotion of Redhook
products (Special Marketing Expense). After giving
effect to the allocation of the Special Marketing Expense, which
was allocated 100% to the Company, and giving effect to income
attributable to the Kona brand, which is shared differently
between the Company and Widmer through 2006, the operating
agreement dictates that remaining profits and losses of Craft
Brands are allocated between the Company and Widmer based on the
cash flow percentages of 42% and 58%, respectively. For the year
ended

December 31, 2006, the Companys share of Craft Brands
net income totaled $2,655,000. For the year ended
December 31, 2005, the Companys share of Craft Brands
net income totaled $2,392,000. The Companys
2005 share of Craft Brands profit was net of $135,000
of the Special Marketing Expense that had been incurred by Craft
Brands during the same period and was fully allocated to the
Company. As of December 31, 2005, the entire $250,000 2004
sales and marketing capital contribution made by the Company had
been used by Craft Brands for designated Special Marketing
Expenses and netted against Craft Brands profits allocated
to the Company. Net cash flow of Craft Brands, if any, is
generally distributed monthly to the Company based on the
Companys cash flow percentage of 42%. During 2006 and
2005, the Company received cash distributions of $2,621,000 and
$2,769,000, respectively, representing its share of the net cash
flow of Craft Brands.

Interest Expense. Interest expense was
$347,000 in 2006, up from $271,000 in 2005. Higher average
interest rates in 2006, partially offset by a declining term
loan balance, resulted in an increase in interest expense.

Other Income, Net. Other income, net increased
by $259,000 to $384,000 in 2006 compared to income of $125,000
in 2005. Results for 2006 include approximately $295,000 of
interest income, an increase of $169,000 over 2005. Results for
2005 include approximately $126,000 in interest income and
$26,000 resulting from loss on the disposal of brewing equipment.

Income Taxes. The Companys effective
income tax rate was a 19.5% expense for 2006 and a 22.0% expense
for 2005. Both periods include a provision for current state
taxes. In 2006, the Company decreased the valuation allowance
that covers net tax operating loss carryforwards and other net
deferred tax assets by $597,000. In 2005, the Company increased
the valuation allowance by $502,000. The valuation allowance
covers a portion of the Companys deferred tax assets,
specifically certain federal and state NOLs that may expire
before the Company is able to utilize the tax benefit.
Realization of the benefit is dependent on the Companys
ability to generate future U.S. taxable income. To the
extent that the Company is unable to generate adequate taxable
income in future periods, the Company will not be able to
recognize additional tax benefits and may be required to record
a greater valuation allowance covering potentially expiring NOLs.

The Company has accounted for its investment in Craft Brands
under the equity method, as outlined by APB No. 18, The
Equity Method of Accounting for Investments in Common Stock.
Pursuant to APB No. 18, the Company has recorded its share
of Craft Brands net income in the Companys statement
of operations as income from equity investment in Craft Brands.
Separate financial statements for Craft Brands are included in
this Annual Report on
Form 10-K
in Part IV., Item 15. Exhibits and Financial
Statement Schedules, in accordance with
Rule 3-09
of
Regulation S-X.
The following summarizes a comparison of certain items from
Craft Brands statements of operations for the years ended
December 31, 2006 and 2005. Certain reclassifications have
been made to the prior years financial statements to
conform to the current year presentation. The effects of the
reclassifications did not affect net income or the profit
allocation.

Sales. Sales totaled $58,664,000 and
$50,787,000 for the years ended December 31, 2006 and 2005.
In addition to selling 122,600 barrels of the
Companys product to wholesalers in the to wholesalers in
the western United States during for the year ended
December 31, 2006 and 126,500 barrels for the year
ended December 31, 2005, Craft Brands also sold products
brewed by Widmer and Kona. Average wholesale revenue per barrel
for all draft products sold by Craft Brands, net of discounts,
increased approximately 3% during 2006 as compared to 2005.
Average wholesale revenue per barrel for all bottle products
sold by Craft Brands, net of discounts, in 2006 remained
relatively unchanged as compared to 2005. For 2006, average
wholesale revenue per barrel for all products sold by Craft
Brands was approximately the same in comparison to 2005. Craft
Brands sales efforts during 2006 and 2005 included a
reduction in discounting on the Companys products. Craft
Brands also pays a fee to A-B in connection with sales to A-B
that are comparable to fees paid by the Company.

Cost of Sales. Cost of sales totaled
$40,454,000 for the year ended December 31, 2006 and
$35,030,000 for the year ended December 31, 2005. On a per
barrel basis, cost of sales decreased modestly due to prices at

which Craft Brands purchased product from the Company and
Widmer. Craft Brands purchases product from the Company and
Widmer at prices substantially below wholesale pricing levels
pursuant to the Supply and Distribution Agreement between Craft
Brands and each of the Company and Widmer. Craft Brands has
realized a slight increase in its average freight cost per
barrel over the Companys historical costs, largely as a
result of increased fuel costs. This has been somewhat offset by
the use of A-B wholesaler support centers and increased
Washington shipments of Widmer Hefeweizen from the
Companys facility.

Selling, General and Administrative
Expenses. Selling, general and administrative
expenses totaled $11,879,000 for the year ended
December 31, 2006 and $9,708,000 for the year ended
December 31, 2005, reflecting all advertising, marketing
and promotion efforts for the Redhook, Widmer and Kona brands.
Higher sales and marketing costs contributed to the increase
from 2005 to 2006 as a result of the hiring for several new
positions, the development and implementation of a web-based
ordering system for wholesaler support items, the development of
new packaging materials, and increased promotional activities.
Selling, general and administrative expenses of Craft Brands for
the first quarter of 2005 include approximately $135,000 of
designated Special Marketing Expenses.

Net Income. Net income totaled $6,339,000 for
the year ended December 31, 2006 and $5,924,000 for the
year ended December 31, 2005. The Companys share of
Craft Brands net income totaled $2,655,000 and $2,392,000
for these respective periods. After giving effect to the
allocation of the Special Marketing Expense, which is allocated
100% to the Company, and giving effect to income attributable to
the Kona brand, which is shared differently between the Company
and Widmer through 2006, the Operating Agreement dictates that
remaining profits and losses of Craft Brands are allocated
between the Company and Widmer based on the cash flow
percentages of 42% and 58%, respectively.

Shipments in January 2008, including shipments of beer brewed on
a contract basis and shipments of Widmer Hefeweizen in
the midwest and east under the licensing agreement with Widmer,
increased 4.7% to 23,900 barrels as compared to shipments
of 22,850 barrels in January 2007. Excluding shipments of
beer brewed on a contract basis at the Washington Brewery and
shipments of Widmer Hefeweizen in the midwest and east
under the licensing agreement with Widmer, shipments of Redhook
products increased 1.0% in January 2008 compared to January
2007, reflecting an increase of approximately 9.3% in shipments
in the midwest and eastern United States and a decrease of
approximately 5.7% in the Craft Brands territory. The Company
believes that sales volume for the first month of a quarter
should not be relied upon as an accurate indicator of results
for future periods. Sales in the craft beer industry generally
reflect a degree of seasonality, with the first and fourth
quarters historically being the slowest and the rest of the year
typically demonstrating stronger sales. The Company has
historically operated with little or no backlog and, therefore,
its ability to predict sales for future periods is limited.

The Company has required capital principally for the
construction and development of its production facilities.
Historically, the Company has financed its capital requirements
through cash flow from operations, bank borrowings and the sale
of common and preferred stock. The Company expects to meet its
future financing needs and working capital and capital
expenditure requirements through cash on hand, operating cash
flow and bank borrowings, and to the extent required and
available, offerings of debt or equity securities.

The Company had $5,527,000 and $9,435,000 of cash and cash
equivalents at December 31, 2007 and 2006, respectively. At
December 31, 2007, the Company had working capital of
$5,714,000. The Companys long-term debt as a percentage of
total capitalization (long-term debt and common
stockholders equity) was 0.05% at December 31, 2007
compared to 6.6% at December 31, 2006. Cash provided by
operating activities totaled $1,597,000 and $4,661,000 for the
years ended December 31, 2007 and 2006, respectively. Cash
provided by operating activities was lower in 2007 as a result
of the decline in operating results, after adjustments, and
normal fluctuations in operating assets and liabilities.

When draft beer is shipped to the wholesaler, the Company
collects a refundable deposit, reflected as a current liability
in the Companys balance sheets. Upon return of the keg to
the Company, the deposit is refunded to the wholesaler. In
conjunction with an industry trend and a policy change initiated
by A-B, the Company also modified its policy, effective
December 1, 2007, to increase the refundable deposit
charged for each keg. The Company collected the higher
refundable deposit for all shipments in December 2007 and for
all kegs held by wholesalers on December 1, 2007, A-B
collected the incremental deposit from the wholesaler on behalf
of the Company. Although the incremental deposit was not
remitted to the Company until 2008, the deposit increase was
reflected in accounts receivable and refundable deposits on the
Companys balance sheet as of December 31, 2007.

The Companys balance sheet as of December 31, 2007
reflects an increase in other current assets of approximately
$839,000 as compared to December 31, 2006, primarily
attributable to a $656,000 increase in refundable deposits paid
to a third party vendor for leased kegs and $154,000 in legal,
consulting and meeting costs incurred in connection with the
proposed merger with Widmer.

During 2007, the Companys capital expenditures totaled
$1,410,000, including approximately $951,000 related to the
expansion of fermentation capacity in the New Hampshire Brewery.
In June 2007, the Company brought an additional
25,000 barrels of fermentation capacity on line at the New
Hampshire Brewery at a cost of nearly $1.3 million. Planned
capital expenditures for fiscal year 2008 are expected to total
approximately $8.8 million. Major 2008 projects include a
two phase expansion of brewing and fermentation capacity at the
New Hampshire Brewery for approximately $6.1 million, the
purchase of additional kegs totaling approximately
$1.5 million, improvements to the refrigeration, water and
yeast handling systems totaling approximately $600,000. Capital
expenditures will be funded with operating cash flows and debt.
If the merger does not close, the Company anticipates that some
of the planned capital expenditures will be delayed.

Since 1997, the Company has had an outstanding credit
arrangement and term loan (the Term Loan) with
U.S. Bank N.A. Although the Term Loan did not mature until
June 2012, the Company elected to repay the outstanding Term
Loan balance of $4,275,000 on December 3, 2007 in
anticipation of entering into a new credit arrangement with Bank
of America N.A. (see discussion below). The new credit
arrangement with Bank of America provides the Company with more
favorable terms than the prior Term Loan, and includes
additional flexibility with respect to 2008 planned capital
equipment expenditures. Additionally, because Widmer also has a
prior banking relationship with Bank of America, the Company
determined that changing their banking relationship prior to the
closing of the merger would permit a smoother post-merger
transition.

The terms of the Companys old Term Loan with
U.S. Bank required the Company to meet certain financial
covenants, computed as of the end of each quarter. The Company
was in compliance with all covenants through September 30,
2007, the last quarterly period in which the Company was
required to comply prior to repaying the balance.

On February 15, 2008, the Company entered into a credit
arrangement with Bank of America, N.A. pursuant to which a
$5 million revolving line of credit is provided (the
Line of Credit). The Line of Credit accrues interest
at a rate equal to, at the Companys option, the
banks prime rate minus 0.50 percentage points or the
14-30 day
LIBOR plus 1.25%. The Company must pay a fee of 0.20% on the
unused portion of the Line of Credit. The Line of Credit is
secured by the Companys equipment and fixtures, inventory,
accounts and receivables. The terms of the Line of Credit
require the Company to meet certain customary financial and
non-financial covenants, including a financial covenant that the
Company must maintain an EBITDA of at least $2 million, as
measured on a rolling 4 quarter basis. As of February 28,
2008, there was no balance outstanding on the Line of Credit,
and the Company was in compliance with all covenants.

Contractual Commitments. The Company has
certain commitments, contingencies and uncertainties relating to
its normal operations. As of December 31, 2007, contractual
commitments associated with the Companys long-term debt,
operating leases and raw material purchase commitments are as
follows (in thousands):

Year Ended December 31,

2008

2009

2010

2011

2012

Thereafter

Total

Long-term debt(1)

$

18

$

18

$

12

$

3

$



$



$

51

Operating leases(2)

275

269

276

277

278

11,268

12,643

Malt and hop commitments(3)

4,024

1,889

1,613

1,245

1,042

885

10,698

Other operational commitments(4)

120

36

20

2





178

$

4,437

$

2,212

$

1,921

$

1,527

$

1,320

$

12,153

$

23,570

(1)

Represents annual lease payments (including portion of payments
imputed as interest) on capital lease obligations. Interest on
capital leases is calculated at the Companys incremental
borrowing rate at the inception of each lease.

Represents purchase commitments to ensure that the Company has
the necessary supply of malted barley and specialty hops to meet
future production requirements. Payments for malted barley are
made as deliveries are received. Hop contracts generally provide
for payment upon delivery of the product with the balance due on
any unshipped product during the year following the harvest
year. The Company believes that, based upon its relationships
with its hop suppliers, the risk of non-delivery is low and that
if non-delivery of its required supply of hops were to occur,
the Company would be able to purchase hops to support its
operations from other competitive sources. Malt and hop
commitments in excess of future requirements, if any, will not
materially affect the Companys financial condition or
results of operations.

The Company does not provide forecasts of future financial
performance or sales volumes, although this Annual Report
contains certain other types of forward-looking statements that
involve risks and uncertainties. The Company may, in discussions
of its future plans, objectives and expected performance in
periodic reports filed by the Company with the Securities and
Exchange Commission (or documents incorporated by reference
therein) and in written and oral presentations made by the
Company, include forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933, as amended,
or Section 21E of the Securities Exchange Act of 1934, as
amended. Such forward-looking statements are based on
assumptions that the Company believes are reasonable, but are by
their nature inherently uncertain. In all cases, there can be no
assurance that such assumptions will prove correct or that
projected events will occur. Actual results could differ
materially from those projected depending on a variety of
factors, including, but not limited to, the successful execution
of market development and other plans, the availability of
financing and the issues discussed in Item 1A.
Risk Factors above. In the event of a negative
outcome of any one these factors, the trading price of the
Companys Common Stock could decline and an investment in
the Companys Common Stock could be impaired.

The Companys financial statements are based upon the
selection and application of significant accounting policies
that require management to make significant estimates and
assumptions. Management believes that the following are some of
the more critical judgment areas in the application of the
Companys accounting policies that currently affect its
financial condition and results of operations. Judgments and
uncertainties affecting the application of these policies may
result in materially different amounts being reported under
different conditions or using different assumptions.

Income Taxes. The Company records federal and
state income taxes in accordance with FASB
SFAS No. 109, Accounting for Income Taxes.
Deferred income taxes or tax benefits reflect the tax effect of
temporary differences between the amounts of assets and
liabilities for financial reporting purposes and amounts as
measured for tax purposes as well as for tax net operating loss
and credit carryforwards.

In June 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109. FIN 48
clarifies the accounting and disclosure requirements for
uncertainty in income taxes recognized in an entitys
financial statements in accordance with SFAS No. 109.
The interpretation prescribes the minimum recognition threshold
and measurement attribute required to be met before a tax
position that has been taken or is expected to be taken is
recognized in the financial statements. FIN 48 also
provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and
transition, and clearly excludes uncertainty in income taxes
from guidance prescribed by FASB No. 5, Accounting for
Contingencies. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company adopted this
interpretation on January 1, 2007. The adoption of
FIN 48 did not have a material impact on the Companys
balance sheet or statement of operations.

As of December 31, 2007 and 2006, the Companys
deferred tax assets were primarily comprised of federal NOLs,
federal and state alternative minimum tax credit carryforwards,
and state NOL carryforwards. As of December 31, 2007, the
Company had federal NOLs of $24.7 million, or
$8.4 million tax-effected; federal and state alternative
minimum tax credit carryforwards of $185,000; and state NOL
carryforwards of $196,000 tax-effected. The federal NOLs expire
from 2012 through 2023; the alternative minimum tax credit can
be utilized to offset regular tax liabilities in future years
and has no expiration date; and the state NOLs expire from 2008
through 2023. In assessing the realizability of the deferred tax
assets, the Company considered both positive and negative
evidence when measuring the need for a valuation allowance. The
ultimate realization of deferred tax assets is dependent upon
the existence of, or generation of, taxable income during the
periods in which those temporary differences become deductible.
The Company considered the scheduled reversal of deferred tax
liabilities, projected future taxable income and other factors
in making this assessment. The Companys estimates of
future taxable income take into consideration, among other
items, estimates of future taxable income related to
depreciation. Based upon the available evidence, the Company
does not believe that all of the deferred tax assets will be
realized. Accordingly, the Companys balance sheets as of
December 31, 2007 and 2006 include a valuation allowance of
$1,059,000 to cover certain federal and state NOLs that may
expire before the Company is able to utilize the tax benefit. To
the extent that the Company continues to be unable to generate
adequate taxable income in future periods, the Company will not
be able to recognize additional tax benefits and may be required
to record a greater valuation allowance covering potentially
expiring NOLs.

There were no unrecognized tax benefits as of January 1,
2007 or December 31, 2007.

Tax years that remain open for examination by the Internal
Revenue Service include 2004, 2005, 2006 and 2007. In addition,
tax years from 1997 to 2003 may be subject to examination
by the Internal Revenue Service to the extent that the Company
utilizes the NOLs from those years in its current year or future
year tax returns.

Long-Lived Assets. The Company evaluates
potential impairment of long-lived assets in accordance with
SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS No. 144
establishes procedures for review of recoverability and
measurement of impairment, if necessary, of long-lived assets,
goodwill and certain identifiable intangibles. When facts and
circumstances indicate that the carrying values of long-lived
assets may be impaired, an evaluation of recoverability is
performed by comparing the carrying value of the assets to
projected future undiscounted cash flows in addition to other
quantitative and qualitative analyses. Upon indication that the
carrying value of such assets may not be recoverable, the
Company will recognize an impairment loss by a charge against
current operations. Fixed assets are grouped at the lowest level
for which there are identifiable cash flows when assessing
impairment. During 2007, the Company performed an analysis of
its brewery assets to determine if an impairment might exist.
The Companys estimate of future undiscounted cash flows
indicated that such carrying values were expected to be
recovered.

Nonetheless, it is possible that the estimate of future
undiscounted cash flows may change in the future, resulting in
the need to write down those assets to their fair value.

Investment in Craft Brands Alliance LLC. The
Company has assessed its investment in Craft Brands pursuant to
the provisions of FASB Interpretation No. 46 Revised,
Consolidation of Variable Interest Entities  an
Interpretation of ARB No. 51. FIN 46R clarifies
the application of consolidation accounting for certain entities
that do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial
support from other parties or in which equity investors do not
have the characteristics of a controlling financial interest;
these entities are referred to as variable interest entities.
Variable interest entities within the scope of FIN 46R are
required to be consolidated by their primary beneficiary. The
primary beneficiary of a variable interest entity is determined
to be the party that absorbs a majority of the entitys
expected losses, receives a majority of its expected returns, or
both. FIN 46R also requires disclosure of significant
variable interests in variable interest entities for which a
company is not the primary beneficiary. The Company has
concluded that its investment in Craft Brands meets the
definition of a variable interest entity but that the Company is
not the primary beneficiary. In accordance with FIN 46R,
the Company has not consolidated the financial statements of
Craft Brands with the financial statements of the Company, but
instead accounted for its investment in Craft Brands under the
equity method, as outlined by APB No. 18, The Equity
Method of Accounting for Investments in Common Stock. The
equity method requires that the Company recognize its share of
the net earnings of Craft Brands by increasing its investment in
Craft Brands on the Companys balance sheet and recognizing
income from equity investment in the Companys statement of
operations. A cash distribution or the Companys share of a
net loss reported by Craft Brands is reflected as a decrease in
investment in Craft Brands on the Companys balance sheet.
The Company does not control the amount or timing of cash
distributions by Craft Brands. For the years ended
December 31, 2007 and 2006, the Company recognized
$2,826,000 and $2,655,000, respectively, of undistributed
earnings related to its investment in Craft Brands, and received
cash distributions of $2,538,000 and $2,621,000, respectively,
representing its share of the net cash flow of Craft Brands. The
Companys share of the earnings of Craft Brands contributed
a significant portion of income to the Companys results of
operations. The Company periodically reviews its investment in
Craft Brands to insure that it complies with the guidelines
prescribed by FIN 46R.

Refundable Deposits on Kegs. The Company
distributes its draft beer in kegs that are owned by the Company
as well as in kegs that have been leased from third parties.
Kegs that are owned by the Company are reflected in the
Companys balance sheets at cost and are depreciated over
the estimated useful life of the keg. When draft beer is shipped
to the wholesaler, regardless of whether the keg is owned or
leased, the Company collects a refundable deposit, reflected as
a current liability in the Companys balance sheets. Upon
return of the keg to the Company, the deposit is refunded to the
wholesaler. When a wholesaler cannot account for some of the
Companys kegs for which it is responsible, the wholesaler
pays the Company, for each keg determined to be lost, a fixed
fee and also forfeits the deposit. For the years ended
December 31, 2007 and 2005, the Company reduced its brewery
equipment by $716,000 and $305,000, respectively, comprised of
lost keg fees and forfeited deposits.

Because of the significant volume of kegs handled by each
wholesaler and retailer, the similarities between kegs owned by
most brewers, and the relatively low deposit collected on each
keg when compared to the market value of the keg, the Company
has experienced some loss of kegs and anticipates that some loss
will occur in future periods. The Company believes that this is
an industry-wide problem and the Companys loss experience
is typical of the industry. In order to estimate forfeited
deposits attributable to lost kegs, the Company periodically
uses internal records, A-B records, other third party records,
and historical information to estimate the physical count of
kegs held by wholesalers and A-B. These estimates affect the
amount recorded as fixed assets and refundable deposits as of
the date of the financial statements. The actual liability for
refundable deposits could differ from estimates. For the year
ended December 31, 2007, the Company decreased its
refundable deposits and brewery equipment by $48,000. For the
year ended December 31, 2006, the Company reduced its
refundable deposits and brewery equipment by $643,000. As of
December 31, 2007 and 2006, the Companys balance
sheets include $3,114,000 and $1,962,000, respectively, in
refundable deposits on kegs and $655,000 and $1,534,000 in keg
fixed assets, net of accumulated depreciation.

Revenue Recognition. The Company recognizes
revenue from product sales, net of excise taxes, discounts and
certain fees the Company must pay in connection with sales to
A-B, when the products are shipped to customers. Although title
and risk of loss do not transfer until delivery of the
Companys products to A-B or the A-B distributor, the
Company recognizes revenue upon shipment rather than when title
passes because the time between shipment and delivery is short
and product damage claims and returns are immaterial. The
Company recognizes revenue on retail sales at the time of sale.
The Company recognizes revenue from events at the time of the
event.

In June 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109. FIN 48
clarifies the accounting and disclosure requirements for
uncertainty in income taxes recognized in an entitys
financial statements in accordance with SFAS No. 109.
The interpretation prescribes the minimum recognition threshold
and measurement attribute required to be met before a tax
position that has been taken or is expected to be taken is
recognized in the financial statements. FIN 48 also
provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and
transition, and clearly excludes uncertainty in income taxes
from guidance prescribed by FASB No. 5, Accounting for
Contingencies. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company adopted this
interpretation on January 1, 2007. The adoption of
FIN 48 did not have a material impact on the Companys
balance sheet or statement of operations.

In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements. SFAS No. 157 defines
fair value, establishes a framework for measuring fair value in
accordance with GAAP, and enhances disclosures about fair value
measurements required under other accounting pronouncements, but
does not change existing guidance as to whether or not an
instrument is carried at fair value. SFAS No. 157
applies whenever other standards require, or permit, assets or
liabilities to be measured at fair value. FASB No. 157 is
effective for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. In November
2007, FASB agreed to a one-year deferral of the effective date
for nonfinancial assets and liabilities that are recognized or
disclosed at fair value on a nonrecurring basis. Early adoption
is permitted. The adoption of SFAS No. 157 as of
December 31, 2006 did not have a material impact on the
Companys results of operations or financial condition.

In February 2007, FASB issued SFAS No. 159, The
Fair Value Option for Financial Assets and Financial
Liabilities  Including an Amendment of FASB Statement
No. 115. SFAS No. 159 permits entities to
choose to measure many financial instruments and certain other
items at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate
volatility in reported earnings caused by measuring related
assets and liabilities differently without having to apply
complex hedge accounting provisions. SFAS No. 159 is
expected to expand the use of fair value measurement, which is
consistent with the FASBs long-term measurement objectives
for accounting for financial instruments. SFAS No. 159
is effective for fiscal years beginning after November 15,
2007 but early adoption is permitted. The Company is currently
evaluating the requirements and impact, if any, of
SFAS No. 159 and has not yet determined the impact on
the Companys financial statements.

In December 2007, the FASB issued SFAS No. 141(R),
Business Combinations. SFAS No. 141(R), which
replaces SFAS No. 141, Business Combinations,
requires an acquirer to recognize the assets acquired, the
liabilities assumed, and any non-controlling interest in the
acquiree at the acquisition date, measured at their fair values
as of that date, with limited exceptions.
SFAS No. 141(R) also requires the acquirer in a
business combination achieved in stages to recognize the
identifiable assets and liabilities, as well as the
non-controlling interest in the acquiree, at the full amounts of
their fair values. SFAS No. 141(R) makes various other
amendments to authoritative literature intended to provide
additional guidance or to confirm the guidance in that
literature to that provided in this statement.
SFAS No. 141(R) applies prospectively to business
combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or
after December 15, 2008. The objective of
SFAS No. 141(R) is to improve the relevance,
representational faithfulness, and comparability of the
information that a reporting entity provides in its financial
reports about a business combination and its effects. The
Company is currently evaluating the impact

that SFAS No. 141(R) would have on the proposed merger
with Widmer and has not yet determined the impact on the
Companys financial statements.

In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements  an amendment of ARB No. 51. The
objective of SFAS No. 160 is to improve the relevance,
comparability, and transparency of the financial information
that a reporting entity provides in its consolidated financial
statements. SFAS No. 160 establishes accounting and
reporting standards that require the ownership interests in
subsidiaries not held by the parent to be clearly identified,
labeled and presented in the consolidated statement of financial
position within equity, but separate from the parents
equity. This statement also requires the amount of consolidated
net income attributable to the parent and to the non-controlling
interest to be clearly identified and presented on the face of
the consolidated statement of income. Changes in a parents
ownership interest while the parent retains its controlling
financial interest must be accounted for consistently, and when
a subsidiary is deconsolidated, any retained non-controlling
equity investment in the former subsidiary must be initially
measured at fair value. The gain or loss on the deconsolidation
of the subsidiary is measured using the fair value of any
non-controlling equity investment. SFAS No. 160 also
requires entities to provide sufficient disclosures that clearly
identify and distinguish between the interests of the parent and
the interests of the non-controlling owners. This Statement
applies prospectively to all entities that prepare consolidated
financial statements and applies prospectively for fiscal years,
and interim periods within those fiscal years, beginning on or
after December 15, 2008. The Company is currently
evaluating the impact that SFAS No. 160 would have on
the proposed merger with Widmer and has not yet determined the
impact on the Companys financial statements.

In December 2007, the Emerging Issues Task Force
(EITF) of the FASB reached a consensus on issue
No. 07-1,Accounting for Collaborative Arrangements. The EITF
concluded on the definition of a collaborative arrangement and
that revenues and costs incurred with third parties in
connection with collaborative arrangements would be presented
gross or net based on the criteria in EITF
No. 99-19
and other accounting literature. Based on the nature of the
arrangement, payments to or from collaborators would be
evaluated and its terms, the nature of the entitys
business, and whether those payments are within the scope of
other accounting literature would be presented. Companies are
also required to disclose the nature and purpose of
collaborative arrangements along with the accounting policies
and the classification and amounts of significant financial
statement balances related to the arrangements. Activities in
the arrangement conducted in a separate legal entity should be
accounted for under other accounting literature; however
required disclosure under EITF
No. 07-1
applies to the entire collaborative agreement. EITF
No. 07-1
is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods
within those fiscal years, and is to be applied retrospectively
to all periods presented for all collaborative arrangements
existing as of the effective date. The Company does not expect
this will have a significant impact on the financial statements
of the Company.

Item 7A.

Quantitative
and Qualitative Disclosures about Market Risk

The Company has assessed its vulnerability to certain market
risks, including interest rate risk associated with financial
instruments included in cash and cash equivalents and long-term
debt. Due to the nature of these investments and the
Companys investment policies, the Company believes that
the risk associated with interest rate fluctuations related to
these financial instruments does not pose a material risk.

The Company did not have any derivative financial instruments as
of December 31, 2007.

We have audited the accompanying balance sheets of Redhook Ale
Brewery, Incorporated (the Company) as of
December 31, 2007 and 2006 and the related statements of
operations, common stockholders equity and cash flows for
each of the years in the three year period ended
December 31, 2007. These financial statements are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included
consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion
on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no such opinion. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position
of Redhook Ale Brewery, Incorporated as of December 31,
2007 and 2006, and the results of its operations and its cash
flows for each of the years in the three year period ended
December 31, 2007, in conformity with accounting principles
generally accepted in the United States of America.

As described in Note 3 to the financial statements,
effective January 1, 2006, the Company changed its method
of accounting for share-based payment arrangements to conform to
Statement of Financial Accounting Standards No. 123(R),
Share-Based Payment.

Redhook Ale Brewery, Incorporated (the Company or
Redhook) was formed in 1981 to brew and sell craft
beer. The Company produces its specialty bottled and draft
products in its two Company-owned breweries. The Washington
Brewery, located in the Seattle suburb of Woodinville,
Washington, began limited operations in late 1994 and became
fully operational after additional phases of construction were
completed in 1996 and 1997. The Companys New Hampshire
Brewery, located in Portsmouth, New Hampshire, began brewing
operations in late 1996 and expanded its operations in 2002,
2003, 2006 and 2007 by increasing its fermentation capacity.
Each brewery also operates a pub on the premises, promoting the
Companys products, offering dining and entertainment
facilities, and selling retail merchandise.

Since 1997, the Companys products have been distributed in
the U.S. in 48 states. Prior to establishing a
distribution relationship with Anheuser-Busch, Incorporated
(A-B) in 1994, the Company distributed its products
regionally through distributors in eight western states:
Washington, California (northern), Oregon, Idaho, Montana,
Wyoming, Colorado and Alaska. In October 1994, the Company
entered into a distribution alliance (the Distribution
Alliance) with A-B, consisting of a national distribution
agreement and an investment by A-B in the Company (the A-B
Investment Agreement). The Distribution Alliance gave the
Company access to A-Bs national distribution network to
distribute its products while existing wholesalers, many of
which were part of the A-B distribution network, continued to
distribute the Companys products outside of the
Distribution Alliance. Pursuant to the A-B Investment Agreement,
A-B invested approximately $30 million to purchase
1,289,872 shares of the Companys convertible
redeemable Series B Preferred Stock (the
Series B Preferred Stock) and
953,470 shares of the Companys common stock
(Common Stock), including 716,714 shares issued
concurrent with the Companys initial public offering.

In August 1995, the Company completed the sale of
2,193,492 shares of Common Stock through an initial public
offering in addition to the 716,714 common shares purchased by
A-B. The net proceeds of the offerings totaled approximately
$46 million.

On July 1, 2004, the Company completed a restructuring of
its ongoing relationship with A-B by executing two new
agreements: an exchange and recapitalization agreement and a
distribution agreement. The terms of the exchange and
recapitalization agreement provided that the Company issue
1,808,243 shares of Common Stock to A-B in exchange for
1,289,872 shares of Series B Preferred Stock held by
A-B. The Series B Preferred Stock, reflected on the
Companys balance sheet at approximately
$16.3 million, was cancelled. In connection with the
exchange, the Company also paid $2.0 million to A-B in
November 2004. The terms of the new distribution agreement with
A-B (the A-B Distribution Agreement) provided for
the Company to continue to distribute its product in the midwest
and eastern U.S. through A-Bs national distribution
network by selling its product to A-B. The A-B Distribution
Agreement has a term that expires on December 31, 2014,
subject to automatic renewal for an additional ten-year period
unless A-B provides written notice of non-renewal to the Company
on or prior to June 30, 2014. The A-B Distribution
Agreement is subject to early termination, by either party, upon
the occurrence of certain events.

On July 1, 2004, the Company also entered into definitive
agreements with Widmer Brothers Brewing Company
(Widmer) with respect to the operation of a joint
venture, Craft Brands Alliance LLC (Craft Brands).
Pursuant to these agreements, the Company and Widmer manufacture
and sell their product to Craft Brands at a price substantially
below wholesale pricing levels; Craft Brands, in turn,
advertises, markets, sells and distributes the Companys
and Widmers products to wholesale outlets in the western
U.S. through a distribution agreement between Craft Brands
and A-B.

On November 13, 2007, the Company entered into an Agreement
and Plan of Merger (the Merger Agreement) with
Widmer, pursuant to which Widmer will merge with and into
Redhook. In connection with the merger, each holder of shares of
common or preferred stock of Widmer will receive, in exchange
for each share held, 2.1551 shares of Redhook Common Stock.
Redhook security holders will continue to own their existing
shares of Redhook Common Stock. The shares of Redhook Common
Stock that Widmer security holders will be entitled to receive
pursuant to the merger are expected to represent approximately
50% of the outstanding shares of the combined company
immediately following the consummation of the merger (assuming
no security holder of Widmer exercises statutory
dissenters rights and that currently outstanding options
held by Redhook employees, officers, directors, and former
directors to acquire shares of Redhook Common Stock are not
exercised prior to the consummation of the merger). In
connection with the merger, Redhook will change its name to
Craft Brewers Alliance, Inc.

Redhook and Widmer have made customary representations,
warranties and covenants in the Merger Agreement, including,
among others, a covenant by Redhook to cause a meeting of
Redhook shareholders to be held to approve issuance of the
shares of Common Stock issuable in the merger. Redhook has also
agreed to use commercially reasonable efforts to cause the
following individuals to be appointed to the following indicated
positions immediately after consummation of the merger: Kurt
Widmer, Chairman of the Board; Paul Shipman, Chairman Emeritus
and Consultant to the Board; David Mickelson, current President
and Chief Operating Officer of Redhook, as Co-Chief Executive
Officer; and Terry Michaelson, current President of Craft Brands
Alliance LLC, as Co-Chief Executive Officer. Redhook has also
agreed to appoint certain other officers of Widmer as officers
of Redhook following consummation of the merger.

The merger is subject to customary conditions to closing,
including (i) regulatory approval from the Alcohol and
Tobacco Tax and Trade Bureau and state licensing agencies,
(ii) approval of A-B, (iii) approval by the requisite
vote of Redhook shareholders of the issuance of the shares of
Common Stock issuable in the merger, (iv) approval of the
merger by the requisite vote of Widmer shareholders,
(v) accuracy of the representations and warranties made by
the parties under the Merger Agreement, (vi) compliance by
the parties with their covenants, and (vii) the absence of
any material adverse change to either Redhook or Widmer.

The Merger Agreement was filed as Exhibit 2.1 to the
current report on
Form 8-K
filed on November 13, 2007.

In connection with the discussions leading up to the Merger
Agreement, the Company has incurred approximately $738,000 in
legal, consulting, meeting and severance costs during the year
ended December 31, 2007. Of the total, approximately
$584,000 is reflected in the statement of operations as selling,
general and administrative expenses and $154,000 has been
capitalized, reflected as other current assets in the balance
sheet, in accordance with Financial Accounting Standards Board
(FASB) Statement of Financial Accounting Standards
(SFAS) No. 141, Business Combinations.

The Company adopted a Company-wide severance plan that requires
the payment of severance benefits to all full-time employees,
other than executive officers, in the event that an
employees employment is terminated as a result of a merger
or other business combination with Widmer Brothers Brewing
Company. The Company is also party to employment arrangements
with its executive officers which provide for severance payments
to such officers upon termination of employment.

The Company considers all highly liquid investments with
original maturities of three months or less to be cash
equivalents. The Company maintains cash and cash equivalent
balances with financial institutions that exceed federally
insured limits. The carrying amount of cash equivalents
approximates fair value because of the short-term maturity of
these instruments.

Accounts receivable is comprised of trade receivables due from
wholesalers and A-B for beer and promotional product sales.
Because of state liquor laws and each wholesalers
agreement with A-B, the Company does not have collectibility
issues related to the sale of its beer products. Accordingly,
the Company does not regularly provide an allowance for doubtful
accounts for beer sales. The Company has provided an allowance
for promotional merchandise that has been invoiced to the
wholesaler. This allowance for doubtful accounts reflects the
Companys best estimate of probable losses inherent in the
accounts receivable balance. The Company determines the
allowance based on historical customer experience and other
currently available evidence. When a specific account is deemed
uncollectible, the account is written off against the allowance.
Accounts receivable on the Companys balance sheets
includes an allowance for doubtful accounts of $95,000 and
$69,000 as of December 31, 2007 and 2006, respectively.

Inventories are stated at the lower of cost or market. Cost is
determined using the
first-in,
first-out method. The Company regularly reviews its inventories
for the presence of obsolete product attributed to age,
seasonality and quality. Inventories that are considered
obsolete are written off or adjusted to carrying value.
Inventories on the Companys balance sheets are reduced by
a $109,000 and $12,000 reserve for obsolescence as of
December 31, 2007 and 2006, respectively. The Company
records as a non-current asset the cost of inventory for which
it estimates it has more than a twelve month supply.

Fixed assets are carried at cost less accumulated depreciation
and accumulated amortization. The cost of repairs and
maintenance are expensed when incurred, while expenditures for
improvements that extend the useful life of an asset are
capitalized. When assets are retired or sold, the asset cost and
related accumulated depreciation or accumulated amortization are
eliminated with any remaining gain or loss reflected in the
statement of operations. Depreciation and amortization of fixed
assets is provided on the straight-line method over the
following estimated useful lives:

The Company has assessed its investment in Craft Brands pursuant
to the provisions of FASB Interpretation No. 46 Revised,
Consolidation of Variable Interest Entities  an
Interpretation of ARB No. 51
(FIN 46R). FIN 46R clarifies the
application of consolidation accounting for certain entities
that do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial
support from other parties or in which equity investors do not
have the characteristics of a controlling financial

interest; these entities are referred to as variable interest
entities. Variable interest entities within the scope of
FIN 46R are required to be consolidated by their primary
beneficiary. The primary beneficiary of a variable interest
entity is determined to be the party that absorbs a majority of
the entitys expected losses, receives a majority of its
expected returns, or both. FIN 46R also requires disclosure
of significant variable interests in variable interest entities
for which a company is not the primary beneficiary. The Company
has concluded that its investment in Craft Brands meets the
definition of a variable interest entity but that the Company is
not the primary beneficiary. In accordance with FIN 46R,
the Company has not consolidated the financial statements of
Craft Brands with the financial statements of the Company, but
instead accounted for its investment in Craft Brands under the
equity method, as outlined by Accounting Principle Board Opinion
(APB) No. 18, The Equity Method of
Accounting for Investments in Common Stock. The equity
method requires that the Company recognize its share of the net
earnings of Craft Brands by increasing its investment in Craft
Brands on the Companys balance sheet and recognizing
income from equity investment in the Companys statement of
operations. A cash distribution or the Companys share of a
net loss reported by Craft Brands is reflected as a decrease in
investment in Craft Brands on the Companys balance sheet.
The Company does not control the amount or timing of cash
distributions by Craft Brands. The Company will periodically
review its investment in Craft Brands to ensure that it complies
with the guidelines prescribed by FIN 46R.

The Company evaluates potential impairment of long-lived assets
in accordance with FASB SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets.
SFAS No. 144 establishes procedures for review of
recoverability and measurement of impairment, if necessary, of
long-lived assets, goodwill and certain identifiable
intangibles. When facts and circumstances indicate that the
carrying values of long-lived assets may be impaired, an
evaluation of recoverability is performed by comparing the
carrying value of the assets to projected future undiscounted
cash flows in addition to other quantitative and qualitative
analyses. Upon indication that the carrying value of such assets
may not be recoverable, the Company recognizes an impairment
loss by a charge against current operations. Fixed assets are
grouped at the lowest level for which there are identifiable
cash flows when assessing impairment. During 2007, the Company
performed an analysis of its brewery assets to determine if
impairment might exist. The Companys estimate of future
undiscounted cash flows indicated that such carrying values were
expected to be recovered.

The Company distributes its draft beer in kegs that are owned by
the Company as well as in kegs that have been leased from third
parties. Kegs that are owned by the Company are reflected in the
Companys balance sheets at cost and are depreciated over
the estimated useful life of the keg. When draft beer is shipped
to the wholesaler, regardless of whether the keg is owned or
leased, the Company collects a refundable deposit, reflected as
a current liability in the Companys balance sheets. Upon
return of the keg to the Company, the deposit is refunded to the
wholesaler. When a wholesaler cannot account for some of the
Companys kegs for which it is responsible, the wholesaler
pays the Company, for each keg determined to be lost, a fixed
fee and also forfeits the deposit. For the years ended
December 31, 2007 and 2005, the Company reduced its brewery
equipment by $716,000 and $305,000, respectively, comprised of
lost keg fees and forfeited deposits. The Company did not
receive lost keg fees during the year ended December 31,
2006.

Because of the significant volume of kegs handled by each
wholesaler and retailer, the similarities between kegs owned by
most brewers, and the relatively low deposit collected on each
keg when compared to the market value of the keg, the Company
has experienced some loss of kegs and anticipates that some loss
will occur in future periods. The Company believes that this is
an industry-wide problem and the Companys loss experience
is typical of the industry. In order to estimate forfeited
deposits attributable to lost kegs, the Company periodically
uses internal records, A-B records, other third party records,
and historical information to estimate the physical count of
kegs held by wholesalers and A-B. These estimates affect the
amount

recorded as fixed assets and refundable deposits as of the date
of the financial statements. The actual liability for refundable
deposits could differ from estimates. For the year ended
December 31, 2007, the Company decreased its refundable
deposits and brewery equipment by $48,000. For the year ended
December 31, 2006, the Company reduced its refundable
deposits and brewery equipment by $643,000. As of
December 31, 2007 and 2006, the Companys balance
sheets include $3,114,000 and $1,962,000, respectively, in
refundable deposits on kegs and $655,000 and $1,534,000 in keg
fixed assets, net of accumulated depreciation.

The Company recognizes revenue from all product sales when the
product is shipped to the customer. Product sales include:
shipments of Redhook products to A-B in the midwest and eastern
U.S., shipments of Widmer Hefeweizen to A-B in the
midwest and eastern U.S. pursuant to the 2003 licensing
agreement, shipments of Redhook products to Craft Brands in the
western U.S., and shipments of Widmer products to Widmer
pursuant to the contract brewing arrangements. Product sales are
recorded net of excise taxes, discounts and, when applicable,
certain fees that the Company must pay in connection with sales
to A-B. Although title and risk of loss do not transfer until
delivery of the Companys products to A-B or the A-B
distributor, the Company recognizes revenue upon shipment rather
than when title passes because the time between shipment and
delivery is short and product damage claims and returns are
immaterial. The Company recognizes revenue on retail sales at
the time of sale. The Company recognizes revenue from events at
the time of the event.

The federal government levies excise taxes on the sale of
alcoholic beverages, including beer. For brewers producing less
than two million barrels of beer per calendar year, the federal
excise tax is $7 per barrel on the first 60,000 barrels of
beer removed for consumption or sale during the calendar year,
and $18 per barrel for each barrel in excess of
60,000 barrels. Individual states also impose excise taxes
on alcoholic beverages in varying amounts. As presented in the
Companys statements of operations, sales reflect the
amount invoiced to A-B, wholesalers and other customers. Excise
taxes due to federal and state agencies are not collected from
the Companys customers, but rather are the responsibility
of the Company. Net sales, as presented in the Companys
statements of operations, are reduced by applicable federal and
state excise taxes.

The Company records federal and state income taxes in accordance
with SFAS No. 109, Accounting for Income Taxes.
Deferred income taxes or tax benefits reflect the tax effect
of temporary differences between the amounts of assets and
liabilities for financial reporting purposes and amounts as
measured for tax purposes as well as for tax net operating loss
and credit carryforwards. These deferred tax assets and
liabilities are measured under the provisions of the currently
enacted tax laws. The Company will establish a valuation
allowance if it is more likely than not that these items will
either expire before the Company is able to realize their
benefits or that future deductibility is uncertain.

In June 2006, the FASB issued Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109,
(FIN 48). FIN 48 clarifies the accounting
and disclosure requirements for uncertainty in income taxes
recognized in an entitys financial statements in
accordance with SFAS No. 109. The interpretation
prescribes the minimum recognition threshold and measurement
attribute required to be met before a tax position that has been
taken or is expected to be taken is recognized in the financial
statements. FIN 48 also provides guidance on derecognition,
classification, interest and penalties,

accounting in interim periods, disclosure and transition, and
clearly excludes uncertainty in income taxes from guidance
prescribed by FASB No. 5, Accounting for
Contingencies. FIN 48 is effective for fiscal years
beginning after December 15, 2006. The Company adopted this
interpretation on January 1, 2007. The adoption of
FIN 48 did not have a material impact on the Companys
balance sheet or statement of operations. There were no
unrecognized tax benefits as of January 1, 2007 or
December 31, 2007.

Penalties incurred in connection with tax matters are classified
as general and administrative expenses, and interest assessments
incurred in connection with tax matters are classified as
interest expense.

Advertising costs, comprised of radio, print and outdoor
advertising, sponsorships and printed product information, as
well as costs to produce these media, are expensed as incurred.
For the years ended December 31, 2007, 2006 and 2005,
advertising expenses totaling $443,000, $365,000 and $533,000,
respectively, are reflected as selling, general and
administrative expenses in the Companys statements of
operations.

The Company incurs costs for the promotion of its products
through a variety of advertising programs with its wholesalers
and downstream retailers. These costs are included in selling,
general and administrative expenses and frequently involve the
local wholesaler sharing in the cost of the program.
Reimbursements from wholesalers for advertising and promotion
activities are recorded as a reduction to selling, general and
administrative expenses in the Companys statements of
operations. Reimbursements for pricing discounts to wholesalers
are recorded as a reduction to sales.

The Company operates in one principal business segment as a
manufacturer of beer and ales across domestic markets. The
Company believes that its pub operations and brewery operations,
whether considered individually or in combination, do not
constitute a separate segment under SFAS No. 131,
Disclosures about Segments of an Enterprise and Related
Information. The Company believes that its two brewery
operations are functionally and financially similar. The Company
operates its two pubs as an extension of its marketing of the
Companys products and views their primary function to be
promotion of the Companys products.

The Company maintains several stock incentive plans under which
non-qualified stock options, incentive stock options and
restricted stock have been granted to employees and non-employee
directors. On January 1, 2006, the Company adopted
SFAS No. 123R, Share-Based Payment, which
revises SFAS No. 123 and supersedes APB No. 25.
SFAS No. 123R requires all share-based payments to
employees and directors be recognized as expense in the
statement of operations based on their fair values and vesting
periods. The Company is required to estimate the fair value of
share-based payment awards on the date of grant using an
option-pricing model. The value of the portion of the award that
is ultimately expected to vest is recognized as expense over the
requisite service periods in the Companys statement of
operations.

The Company follows SFAS No. 128, Earnings per
Share. Basic earnings (loss) per share is calculated using
the weighted average number of shares of Common Stock
outstanding. The calculation of adjusted weighted average shares
outstanding for purposes of computing diluted earnings (loss)
per share includes the dilutive effect of all outstanding stock
options for the periods when the Company reports net income. The
calculation uses the treasury stock method and the as if
converted method in determining the resulting incremental
average equivalent shares outstanding as applicable.

The preparation of the financial statements in conformity with
accounting principles generally accepted in the
U.S. requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and
accompanying notes. Actual results may differ from those
estimates.

The Companys balance sheets include the following
financial instruments: cash and cash equivalents, accounts
receivable, inventory, accounts payable, accrued expenses,
capital lease obligations and long-term debt. The Company
believes the carrying amounts of current assets and liabilities
and indebtedness in the balance sheets approximate the fair
value.

In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements. SFAS No. 157 defines
fair value, establishes a framework for measuring fair value in
accordance with GAAP, and enhances disclosures about fair value
measurements required under other accounting pronouncements, but
does not change existing guidance as to whether or not an
instrument is carried at fair value. SFAS No. 157
applies whenever other standards require, or permit, assets or
liabilities to be measured at fair value. FASB No. 157 is
effective for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. In November
2007, FASB agreed to a one-year deferral of the effective date
for nonfinancial assets and liabilities that are recognized or
disclosed at fair value on a nonrecurring basis. Early adoption
is permitted. The adoption of SFAS No. 157 as of
December 31, 2006 did not have a material impact on the
Companys results of operations or financial condition.

In February 2007, FASB issued SFAS No. 159, The
Fair Value Option for Financial Assets and Financial
Liabilities  Including an Amendment of FASB Statement
No. 115. SFAS No. 159 permits entities to
choose to measure many financial instruments and certain other
items at fair value. The objective is to improve financial
reporting by providing entities with the opportunity to mitigate
volatility in reported earnings caused by measuring related
assets and liabilities differently without having to apply
complex hedge accounting provisions. SFAS No. 159 is
expected to expand the use of fair value measurement, which is
consistent with the FASBs long-term measurement objectives
for accounting for financial instruments. SFAS No. 159
is effective for fiscal years beginning after November 15,
2007 but early adoption is permitted. The Company is currently
evaluating the requirements and impact, if any, of
SFAS No. 159 and has not yet determined the impact on
the Companys financial statements.

In December 2007, the FASB issued SFAS No. 141(R),
Business Combinations. SFAS No. 141(R), which
replaces SFAS No. 141, Business Combinations,
requires an acquirer to recognize the assets acquired, the
liabilities assumed, and any non-controlling interest in the
acquiree at the acquisition date, measured at their fair values
as of that date, with limited exceptions.
SFAS No. 141(R) also requires the acquirer in a
business combination achieved in stages to recognize the
identifiable assets and liabilities, as well as the
non-controlling interest in the acquiree, at the full amounts of
their fair values. SFAS No. 141(R) makes various other
amendments to authoritative literature intended to provide
additional guidance or to confirm the guidance in that
literature to that provided in this statement.
SFAS No. 141(R) applies prospectively to business
combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or
after December 15, 2008. The objective of
SFAS No. 141(R) is to improve the relevance,
representational faithfulness, and comparability of the
information that a reporting entity provides in its financial
reports about a business combination and its effects. The
Company is currently evaluating the impact that
SFAS No. 141(R) would have the proposed merger with
Widmer and has not yet determined the impact on the
Companys financial statements.

In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements  an amendment of ARB No. 51. The
objective of SFAS No. 160 is to improve the relevance,
comparability, and transparency of the financial information
that a reporting entity provides in its consolidated financial
statements. SFAS No. 160 establishes accounting and
reporting standards that require the ownership interests in
subsidiaries not held by the parent to be clearly identified,
labeled and presented in the consolidated statement of financial
position within equity, but separate from the parents
equity. This statement also requires the amount of consolidated
net income attributable to the parent and to the non-controlling
interest to be clearly identified and presented on the face of
the consolidated statement of income. Changes in a parents
ownership interest while the parent retains its controlling
financial interest must be accounted for consistently, and when
a subsidiary is deconsolidated, any retained non-controlling
equity investment in the former subsidiary must be initially
measured at fair value. The gain or loss on the deconsolidation
of the subsidiary is measured using the fair value of any
non-controlling equity investment. SFAS No. 160 also
requires entities to provide sufficient disclosures that clearly
identify and distinguish between the interests of the parent and
the interests of the non-controlling owners. This Statement
applies prospectively to all entities that prepare consolidated
financial statements and applies prospectively for fiscal years,
and interim periods within those fiscal years, beginning on or
after December 15, 2008. The Company is currently
evaluating the impact that SFAS No. 160 would have the
proposed merger with Widmer and has not yet determined the
impact on the Companys financial statements.

In December 2007, the Emerging Issues Task Force
(EITF) of the FASB reached a consensus on issue
No. 07-1,Accounting for Collaborative Arrangements. The EITF
concluded on the definition of a collaborative arrangement and
that revenues and costs incurred with third parties in
connection with collaborative arrangements would be presented
gross or net based on the criteria in EITF
No. 99-19
and other accounting literature. Based on the nature of the
arrangement, payments to or from collaborators would be
evaluated and its terms, the nature of the entitys
business, and whether those payments are within the scope of
other accounting literature would be presented. Companies are
also required to disclose the nature and purpose of
collaborative arrangements along with the accounting policies
and the classification and amounts of significant
financial-statement balances related to the arrangements.
Activities in the arrangement conducted in a separate legal
entity should be accounted for under other accounting
literature; however required disclosure under EITF
No. 07-1
applies to the entire collaborative agreement. EITF
No. 07-1
is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods
within those fiscal years, and is to be applied retrospectively
to all periods presented for all collaborative arrangements
existing as of the effective date. The Company does not expect
this will have a significant impact on the financial statements
of the Company.

Work in process is beer held in fermentation tanks prior to the
filtration and packaging process. Promotional merchandise and
finished goods are reduced by a $109,000 and $12,000 reserve for
obsolescence as of December 31, 2007 and 2006, respectively.

5.

Fixed
Assets

Fixed assets consist of the following:

December 31,

2007

2006

Brewery equipment

$

47,081,696

$

46,387,322

Buildings

35,846,181

35,838,145

Land and improvements

4,604,130

4,601,427

Furniture, fixtures and other equipment

2,339,430

2,284,062

Vehicles

81,730

81,730

Contruction in progress

314,363

460,389

90,267,530

89,653,075

Less accumulated depreciation and amortization

34,405,233

31,576,641

$

55,862,297

$

58,076,434

As of December 31, 2007 and 2006, brewery equipment
included property acquired under a capital lease with a cost of
$77,000 and accumulated amortization of $34,000 and $18,000,
respectively. The Companys statement of operations for the
years ended December 31, 2007 and 2006 includes $15,000 and
$12,000 in amortization expense related to this leased property.

6.

Craft
Brands Alliance LLC

On July 1, 2004, the Company entered into agreements with
Widmer with respect to the operation of a joint venture sales
and marketing entity, Craft Brands. Pursuant to these
agreements, the Company manufactures and sells its product to
Craft Brands at a price substantially below wholesale pricing
levels; Craft Brands, in turn, advertises, markets, sells and
distributes the product to wholesale outlets in the western
U.S. pursuant to a distribution agreement between Craft
Brands and A-B.

The Company and Widmer have entered into a restated operating
agreement with Craft Brands, as amended (the Operating
Agreement), that governs the operations of Craft Brands
and the obligations of its members, including capital
contributions, loans and allocation of profits and losses.

The Operating Agreement requires the Company to make certain
capital contributions to support the operations of Craft Brands.
Contemporaneous with the execution of the Operating Agreement,
the Company made a 2004 sales and marketing capital contribution
in the amount of $250,000. The agreement designated that this
sales and marketing capital contribution be used by Craft Brands
for expenses related to the marketing, advertising and promotion
of the Companys products (Special Marketing
Expense). In February 2007 and in February 2008, the
Company and Widmer amended the Operating Agreement to require an
additional sales and marketing contribution in 2009 if the
volume of sales of Redhook products in 2008 in the Craft Brands
territory is less than 92% of the volume of sales of Redhook
products in 2003 in the Craft Brands territory. Under these
amendments, Redhooks maximum 2009 sales and marketing
contribution was reduced to $310,000, reflecting the
Companys commitment to expand the production capacity of
its Washington and New Hampshire breweries to produce more
Widmer products. Widmer also has a sales and marketing
contribution under the amended Operating Agreement with similar
terms that is capped at $750,000. If required, the 2009 sales
and marketing contribution is due by February 1, 2009.
Because sales in

the craft beer industry generally reflect a degree of
seasonality and the Company has historically operated with
little or no backlog, the Companys ability to predict
sales for future periods is limited. Accordingly, the Company
cannot predict to what degree, if at all, the Company will be
required to make this 2009 sales and marketing contribution. If
the Company is required to make this additional sales and
marketing contribution in 2009, the Companys available
cash will decrease and income from Craft Brands will decrease by
the amount of the contribution, which will be allocated 100% to
the Company. The Operating Agreement also obligates the Company
and Widmer to make other additional capital contributions only
upon the request and consent of the Craft Brands board of
directors.

The Operating Agreement also requires the Company and Widmer to
make loans to Craft Brands to assist Craft Brands in conducting
its operations and meeting its obligations. To the extent that
cash flow from operations and borrowings from financial
institutions is not sufficient for Craft Brands to meet its
obligations, the Company and Widmer are obligated to lend to
Craft Brands the funds the president of Craft Brands deems
necessary to meet such obligations. As of December 31, 2007
and 2006, there were no loan obligations due to the Company.

The Operating Agreement also addresses the allocation of profits
and losses of Craft Brands. After giving effect to the
allocation of the sales and marketing capital contribution, if
any, and after giving effect to income attributable to the
shipments of the Kona brand, which was shared differently
between the Company and Widmer through 2006, the remaining
profits and losses of Craft Brands are allocated between the
Company and Widmer based on the cash flow percentages of 42% and
58%, respectively. Net cash flow, if any, will generally be
distributed monthly to the Company and Widmer based upon these
cash flow percentages. No distribution will be made to the
Company or Widmer unless, after the distribution is made, the
assets of Craft Brands will be in excess of its liabilities,
with the exception of liabilities to members, and Craft Brands
will be able to pay its debts as they become due in the ordinary
course of business.

For the years ended December 31, 2007, 2006 and 2005, the
Companys share of Craft Brands net income totaled
$2,826,000, $2,655,000 and $2,392,000, respectively. The
2005 share of Craft Brands profit was net of $135,000
of the Special Marketing Expense that had been incurred by Craft
Brands during the same period and was fully allocated to the
Company. As of December 31, 2005, the entire $250,000 2004
sales and marketing capital contribution made by the Company had
been used by Craft Brands for designated Special Marketing
Expenses and netted against Craft Brands profits allocated
to the Company.

During 2007, 2006 and 2005, the Company received cash
distributions of $2,538,000, $2,621,000 and $2,769,000,
respectively, representing its share of the net cash flow of
Craft Brands. As of December 31, 2007 and 2006, the
Companys investment in Craft Brands totaled $416,000 and
$128,000, respectively.

In connection with shipments of the Companys products to
Craft Brands, the Company recognized sales of $13,885,000,
$13,953,000 and $14,298,000 in the statements of operations
during the years ended December 31, 2007, 2006 and 2005,
respectively. For the year ended December 31, 2007,
shipments of the Companys products to Craft Brands
represented approximately 38% of total Company shipments, or
121,900 barrels. For the year ended December 31, 2006,
shipments of the Companys products to Craft Brands
represented 45% of total Company shipments, or
122,600 barrels. For the year ended December 31, 2005,
shipments of the Companys products to Craft Brands
represented 56% of total Company shipments, or
126,500 barrels.

In conjunction with the sale of Redhook product to Craft Brands,
the Companys balance sheets as of December 31, 2007
and 2006 reflect a trade receivable due from Craft Brands of
approximately $670,000 and $855,000, respectively. In
conjunction with the sale of Redhook products in Washington
state, where state liquor regulations require that the Company
sell its product directly to third-party beer distributors, the
Companys balance sheets as of December 31, 2007 and
2006 reflect a trade payable to Craft Brands, based upon a
contractually determined formula, of approximately $416,000 and
$325,000, respectively.

Separate financial statements for Craft Brands are filed with
the Companys
Form 10-K
for the year ended December 31, 2007, Part IV, in
Item 15. Exhibits and Financial Statement Schedules,
in accordance with
Rule 3-09
of
Regulation S-X.

7.

Debt and
Capital Lease Obligations

Long-term debt and capital lease obligations consist of the
following:

Since 1995, the Company has had a credit agreement with a bank
under which a term loan, which originated in 1997 (the
Term Loan), had been provided. Although the credit
agreement was amended in June 2006 to extend the maturity date
from June 2007 to June 2012, the Company elected to repay the
outstanding Term Loan balance of $4,275,000 on December 3,
2007. The Term Loan was secured by substantially all of the
Companys assets. Interest on the Term Loan accrued at
London Inter Bank Offered Rate (LIBOR) plus 1.75%
and the Company had the option to fix the applicable interest
rate for up to twelve months by selecting LIBOR for one- to
twelve- month periods as a base. The credit agreement provided
that the termination of the A-B Distribution Agreement for any
reason would have constituted an event of default under the
credit agreement and the bank would have had the option to
declare the entire outstanding loan balance immediately due and
payable. The terms of the credit agreement required the Company
to meet certain financial covenants, computed as of the end of
each quarter. The Company was in compliance with all covenants
through September 30, 2007, the last quarterly period in
which the Company was required to comply prior to repaying the
balance.

In August 1995, the Company completed the sale of
2,193,492 shares of Common Stock through an initial public
offering and 716,714 common shares in a concurrent private
placement to A-B (collectively, the Offerings) at a
price of $17.00 per share. The net proceeds of the Offerings
totaled approximately $46 million. All of the
1,242,857 shares of Series A convertible preferred
stock automatically converted to an equal number of common
shares upon closing of the Offerings.

On July 1, 2004, the Company issued 1,808,243 shares
of Common Stock to A-B in exchange for 1,289,872 shares of
Series B Preferred Stock held by A-B. The Series B
Preferred Stock was cancelled. A-B was also granted certain
contractual registration rights with respect to the shares of
Common Stock held by
A-B. In
connection with the exchange, the Company paid $2,000,000 to A-B
in November 2004. The impact of this exchange and
recapitalization on the balance sheet as of December 31,
2004 was to reduce convertible preferred stock by $16,300,000,
increase Common Stock by $9,000, increase additional paid-in
capital by $14,200,000 and reduce cash by $2,000,000. As of
December 31, 2007 and 2006, A-B held 33.1% and 33.3% of the
Companys outstanding shares of Common Stock, respectively.

In conjunction with the exercise of stock options granted under
the Companys stock option plans, the Company issued
48,550 shares of the Companys Common Stock and
received proceeds on exercise totaling $157,000 during the year
ended December 31, 2007. During the year ended
December 31, 2006, the Company issued 58,880 shares of
Common Stock and received proceeds on exercise totaling $150,000.

Following shareholder approval of the 2007 Stock Incentive Plan
at the May 22, 2007 Annual Meeting of Shareholders, the
board of directors approved the following fully-vested stock
grants under the 2007 Plan: 2,300 shares of Common Stock to
each independent, non-employee director, 10,000 shares of
Common Stock to the Chief Executive Officer Paul Shipman, and
5,000 shares of Common Stock to President David Mickelson.
In conjunction with these stock grants, the Company issued
24,200 shares of Common Stock and recognized stock-based
compensation expense of $169,000 in the year ended
December 31, 2007.

The Company maintains several stock incentive plans under which
non-qualified stock options, incentive stock options and
restricted stock are granted to employees and non-employee
directors. The Company issues new shares of Common Stock upon
exercise of stock options.

The Company maintains the 1992 Stock Incentive Plan, as amended
(the 1992 Plan) and the Amended and Restated
Directors Stock Option Plan (the Directors Plan)
under which non-qualified stock options and incentive stock
options were granted to employees and non-employee directors
through October 2002. Employee options were generally designated
to vest over a five-year period while director options became
exercisable six months after the grant date. Vested options are
generally exercisable for ten years from the date of grant.
Although the 1992 Plan and the Directors Plan both expired in
October 2002, preventing further option grants, the provisions
of these plans remain in effect until all options terminate or
are exercised.

The Companys shareholders approved the 2002 Stock Option
Plan (the 2002 Plan) in May 2002. The 2002 Plan
provides for granting of non-qualified stock options and
incentive stock options to employees, non-employee directors and
independent consultants or advisors. The compensation committee
of the board of directors administers the 2002 Plan, determining
to whom options are to be granted, the number of shares of
Common Stock for which the options are exercisable, the purchase
prices of such shares, and all other terms and conditions.
Options granted to employees of the Company in 2002 under the
2002 Plan were designated to vest over a five-year period, and
options granted to the Companys directors in 2002, 2003,
2004 and 2005 under the 2002 Plan became exercisable six months
after the grant date. Options were granted at an exercise price
equal to fair market value of the underlying Common Stock on the
grant date and terminate on the tenth anniversary of the grant
date. Options granted in 2006 under the 2002 Plan were granted
to the Companys directors (other than A-B designated
directors) at an exercise price less than the fair market value
of the underlying Common Stock on the grant date. These options
were immediately exercisable and each grantee exercised his
option to purchase this Common Stock on the same day as the
grant. The maximum number of shares of Common Stock for which
options may be granted during the term of the 2002 Plan is
346,000.

The 2007 Stock Incentive Plan (the 2007 Plan) was
adopted by the board of directors and approved by the
shareholders in May 2007. The 2007 Plan provides for stock
options, restricted stock, restricted stock units, performance
awards and stock appreciation rights. While incentive stock
options may only be granted to employees, awards other than
incentive stock options may be granted to employees and
directors. The 2007 Plan is administered by the compensation
committee of the board of directors. A maximum of
100,000 shares of Common Stock are authorized for issuance
under the 2007 Plan.

The Company has reserved approximately 865,000 shares of
Common Stock for future issuance in connection with the exercise
of outstanding options to purchase Common Stock as well as
grants of Common Stock under the 2007 Plan.

Prior to the January 1, 2006 adoption of
SFAS No. 123R, Share-Based Payment, the Company
accounted for its employee and director stock-based compensation
plans using the intrinsic value method, as prescribed by APB
No. 25, Accounting for Stock Issued to Employees.
Under the intrinsic value method, no stock-based compensation
expense was recognized in the Companys statement of
operations because the exercise price of the Companys
stock options granted to employees and directors equaled the
fair market value of the underlying Common Stock on the date of
grant. As permitted, for all periods prior to January 1,
2006, the Company elected to adopt the disclosure only
provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, as amended by
SFAS No. 148.

On November 29, 2005, the board of directors of the Company
approved an acceleration of vesting of all of the Companys
unvested stock options (the Acceleration). The
Acceleration was effective for stock options outstanding as of
December 30, 2005. These options were granted under the
1992 Plan and 2002 Plan. As a result of the Acceleration,
options to acquire approximately 136,000 shares of the
Companys Common Stock, or 16% of total outstanding
options, became exercisable on December 30, 2005. Of the
approximately 136,000 shares subject to the Acceleration,
options to acquire approximately 70,000 shares of the
Companys Common Stock at an exercise price of $1.865 would
have otherwise fully vested in August 2006, and options to
acquire approximately 66,000 shares of the Companys
Common Stock at an exercise price of $2.019 would have otherwise
vested in August 2006 and August 2007. The Acceleration did not
have a material impact on 2006 or 2007 results of operations.

On January 1, 2006, the Company adopted
SFAS No. 123R, Share-Based Payment, which
revises SFAS No. 123 and supersedes APB No. 25.
SFAS No. 123R requires all share-based payments to
employees and directors be recognized as expense in the
statement of operations based on their fair values and vesting
periods. The Company is required to estimate the fair value of
share-based payment awards on the date of grant using an
option-pricing model. The value of the portion of the award that
is ultimately expected to vest is recognized as expense over the
requisite service periods in the Companys statement of
operations. The Company elected to follow the modified
prospective transition method, one of two methods
prescribed by the standard, for implementing
SFAS No. 123R. Under the modified prospective method,
compensation cost is recognized beginning with the effective
date (i) based on the requirements of
SFAS No. 123R for all share-based payments granted
after the effective date and (ii) based on the requirements
of SFAS No. 123 for all awards granted to employees
prior to the effective date of SFAS No. 123R that
remain unvested on the effective date. No compensation expense
was recognized in 2007 or 2006 for stock options outstanding as
of December 31, 2005 because these options were fully
vested prior to the January 1, 2006 adoption of
SFAS No. 123R.

On May 25, 2005, each non-employee director (other than A-B
designated directors) was granted an option to purchase
4,000 shares of Common Stock at an exercise price of $3.15
per share. The options were granted at an exercise price equal
to the fair market value on the grant date, became exercisable
six months after the grant date, and will terminate on the tenth
anniversary of the grant date. The options were granted under
the Companys 2002 Plan. There were no other grants of
options to purchase Common Stock in 2005.

On May 23, 2006, following the Companys Annual
Meeting of Shareholders, each non-employee director (other than
A-B designated directors) was granted an immediately exercisable
option to purchase 3,500 shares of Common Stock at $0.01
per share (the Options). The Options expired on
June 30, 2006 and were granted under the Companys
2002 Plan. On May 23, 2006, each grantee exercised his
option to purchase 3,500 shares of Common Stock. The option
grant resulted in stock compensation expense of $54,000. There
were no other grants of options to purchase Common Stock in 2006.

On May 22, 2007, the board of directors approved a grant of
2,300 shares of fully-vested Common Stock to each
independent, non-employee director, 10,000 shares of
fully-vested Common Stock to the Chief Executive Officer Paul
Shipman, and 5,000 shares of fully-vested Common Stock to
President David Mickelson under the 2007 Plan. In conjunction
with these stock grants, the Company issued 24,200 shares
of Common Stock and recognized stock-based compensation expense
of $169,000 in the Companys statement of operations for
the year ended December 31, 2007. There were no other
grants of Common Stock or options to purchase Common Stock in
2007.

The following table illustrates the effect on net loss and loss
per share for the year ended December 31, 2005 had
compensation cost for the Companys stock options been
recognized based upon the estimated fair value on the grant date
under the fair value methodology as prescribed by the disclosure
only provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, as amended by
SFAS No. 148. Stock compensation disclosure for the
years ended December 31, 2007 and 2006 is not presented
below because, in accordance with SFAS No. 123R, any
expense is required to be recognized in the financial statements.

Year Ended

December 31,

2005

Net loss as reported

$

(1,200,443

)

Add: Stock compensation as reported under APB 25



Less: Stock-based employee compensation expense
determined under the fair value based method for all options,
net of related tax effects

(244,585

)

Pro forma net loss

$

(1,445,028

)

Net loss per share

Basic

As reported

$

(0.15

)

Proforma

$

(0.18

)

Diluted

As reported

$

(0.15

)

Proforma

$

(0.18

)

The fair value of options granted (which is amortized to expense
over the option vesting period in determining the pro forma
impact) was estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted
average assumptions:

2006

2005

Expected life (years)

0 yrs.

5 yrs.

Risk-free interest rate

4.70

%

3.88

%

Expected volatility rate

0.00

%

46.0

%

Expected dividend yield

0.00

%

0.0

%

The fair value of Common Stock and options granted in 2006 and
2005 was estimated on the date of grant using the Black-Scholes
single option pricing model with the following weighted average
assumptions:

2006

2005

Total number of options granted

14,000

16,000

Estimated fair value of each option granted

$

3.84

$

1.24

Total estimated fair value of all options granted

$

54,000

$

20,000

The expected term of the options represents the estimated period
of time until exercise and was based on historical experience of
similar awards, giving consideration to the contractual terms,
vesting schedules and expectations of future employee behavior.
The risk-free interest rate was based on the implied yield
currently available on U.S. Treasury securities with an
equivalent remaining term. Prior to the adoption of
SFAS No. 123R, expected stock price volatility was
estimated using only historical volatility. The Company has not
paid dividends in the past and does not plan to pay any
dividends in the near future. Because the 2006 grant of options
to purchase Common Stock were immediately exercised by the
director grantees, the expected life of the option and the stock
price volatility were known and not estimated. Refer to the
table of options currently outstanding below for the weighted
average exercise price for options granted during 2007, 2006 and
2005.

Presented below is a summary of stock option plans
activity for the years shown:

Weighted

Weighted

Average

Average

Shares

Exercise

Remaining

Aggregate

Subject to

Price per

Contractual

Intrinsic

Options

Share

Life (Years)

Value

Outstanding at January 1, 2005

1,054,530

$

3.43

5.89

$

624,841

Granted

16,000

$

3.15

Exercised

(34,410

)

$

1.93

Canceled

(189,800

)

$

4.92

Outstanding at December 31, 2005

846,320

$

3.15

5.08

$

700,258

Granted

14,000

$

0.01

Exercised

(58,880

)

$

1.63

Canceled

(18,000

)

$

17.04

Outstanding at December 31, 2006

783,440

$

2.89

4.10

$

1,950,534

Granted



$



Exercised

(48,550

)

$

3.24

Canceled

(45,750

)

$

7.23

Outstanding at December 31, 2007

689,140

$

2.57

3.33

$

2,809,485

Exercisable at December 31, 2007

689,140

$

2.57

3.33

$

2,809,485

The aggregate intrinsic value of the outstanding stock options
is calculated as the difference between the stock closing price
as reported by Nasdaq on of the last day of the period and the
exercise price of the shares. The applicable stock closing
prices as of December 31, 2007, 2006, 2005 were $6.65,
$5.20 and $3.17, respectively. The applicable stock closing
price as of January 1, 2005 was $3.51. For 2007 and 2006,
there was no unrecognized stock-based compensation expense
related to unvested stock options. The total intrinsic value of
stock options exercised in 2007, 2006 and 2005 was $168,000,
$125,000 and $38,000, respectively. The total fair value of
options vested in 2006 was $54,000.

The following table summarizes information for options currently
outstanding and exercisable at December 31, 2007:

Average

Weighted

Number

Remaining

Average

Outstanding &

Contractual Life

Exercise

Range of Exercise Prices

Exercisable

(Yrs)

Price

$

1.485

to

$1.815

8,000

2.89

$

1.650

$

1.816

to

$1.865

322,540

3.59

$

1.865

$

1.866

to

$2.180

142,434

4.69

$

2.028

$

2.181

to

$3.150

34,666

6.46

$

2.768

$

3.151

to

$5.730

181,500

1.21

$

4.263

$

1.485

to

$5.730

689,140

3.33

$

2.573

Under the terms of the Companys incentive stock option
plans, employees and directors may be granted options to
purchase the Companys Common Stock at the market price on
the date the option is granted. Under these stock option plans,
stock options granted at less than the fair market value on the
date of grant

are considered to be non-qualified stock options rather than
incentive stock options. At December 31, 2007, 2006 and
2005, a total of 99,959, 95,959 and 109,559 options,
respectively, were available for future grants under the 2002
plan.

9.

Earnings
(Loss) Per Share

The following table sets forth the computation of basic and
diluted earnings (loss) per common share:

Year Ended December 31,

2007

2006

2005

Numerator for basic and diluted net income (loss) per
share  net income (loss)

$

(939,486

)

$

516,165

$

(1,200,443

)

Denominator for basic net income (loss) per share 
weighted average common shares outstanding